The Regime Has Changed

Editor's note: The meme-stock crowd got burned last year. Now, our colleague Dan Ferris says these folks are missing an even deeper shift in the markets... something he believes is critical to understand. In this excerpt, adapted from the December 15, 2022 Stansberry Digest, Dan explains why the most recent bear market could change the way you invest for years to come...

Retail investors have gone from hero to zero...

After years of being pushed around by institutional investors, they emerged as a new force in the market in 2020 and 2021.

They posted on message boards like Reddit's WallStreetBets forum... And they drove up the prices of meme stocks like GameStop (GME), AMC Entertainment (AMC), and Bed Bath & Beyond (BBBY).

Those episodes famously caused hedge fund Melvin Capital to close its doors due to soured bets against GameStop, despite a multibillion-dollar bailout.

Emboldened by their David-versus-Goliath success story, the "meme stockers" kept at it. They caused similar short-covering spikes in other heavily shorted, money-losing businesses. However, the good times didn't last...

Those stocks and their meme-stock supporters got crushed last year, with BBBY down 83%, GME down 50% (split-adjusted), and AMC down nearly 80%. Yet meme stockers are still posting on Twitter, with hashtags like #tothemoon and #MOASS (mother of all short squeezes).

Part of the problem, of course, is that they're chasing speculative garbage. But that isn't their only mistake.

You see, the retail hyperbulls are missing a crucial fact today. The market conditions have flipped... And in the new regime, your best ideas might now be your worst.

Take a look at the crash in meme stocks last year...

The retail army got bludgeoned. But meme stocks weren't their only disastrous bet...

According to a Wall Street Journal article published late last year, retail investors put a net $1.9 billion into one of their favorite speculative vehicles – the ARK Innovation Fund (ARKK) – in the first five months of 2022. And they bought the dip as the fund fell 53% during that period.

Ultimately, their bets on speculative tech failed, too. Since May 31, ARKK fell another 32% to its December low. And today, it trades about 75% below its all-time high.

It has been said many times that the bull market from 2009 to 2022 was fueled by cheap money provided by the Federal Reserve and other global central banks.

It sure looks like retail investors fell under that spell... Between COVID-19 lockdowns, stimulus checks, and suspended student-loan payments, people found themselves with time on their hands and money to burn. They bought stocks, flexed their muscles enough to cause a few short squeezes, and felt empowered.

But in the end, fundamentals won. It's no longer possible to feel smart for buying ARKK or meme stocks – unless you sold out with a profit.

What the retail hyperbulls tend not to realize until it's too late is that whole classes of equities tend to outperform for years at a time... then underperform for years. There comes a point at which buying the dip is financially suicidal.

It's over. Time to move on.

Investor and author Howard Marks' recent memo, "Sea Change," echoes this point...

He says that he has seen two sea changes in the investment world in his 53-year career. He believes we're living through a third one today.

Marks says the first sea change of his career began with a "new investor mentality" that resulted when the high-yield bond market launched in the 1980s. Suddenly, people didn't run away from risk... Rather, risk was "considered relative to return."

The second sea change came after Paul Volcker became chairman of the Fed and pushed the federal-funds rate to 20% to kill inflation.

Marks points to renewed optimism and "an incredible four decades for the stock market." The S&P 500 Index saw 10.3% compound annual returns from August 1982 to January 2022.

Marks believes it is "nearly impossible to overstate the influence of declining rates over the last four decades." He concludes by summing up the current sea change we're living through (emphasis added)...

We've gone from the low-return world of 2009-21 to a full-return world, and it may become more so in the near term. Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets. Lenders and bargain hunters face much better prospects in this changed environment than they did in 2009-21. And importantly, if you grant that the environment is and may continue to be very different from what it was over the last 13 years – and most of the last 40 years – it should follow that the investment strategies that worked over those periods may not be the ones that outperform in the years ahead.

That's the sea change Marks is talking about. A declining-rate environment is no longer ruling the markets. Investors can stop chasing risk... the opposite of the retail army's strategy last year.

On its own, it doesn't sound so bad, does it?

But earlier in the memo, Marks also says the current moment is "overwhelmingly different from – and mostly less favorable than – those of the post-" era. And he adds, "We're unlikely to quickly see the same optimism and ease that marked the post- period."

However you interpret Marks' comments, one thing is clear...

The past is gone.

Unlike every other bear market of the last four decades, the present moment likely means we're entering a more difficult period of greater risk... but, for the right kind of investor, greater reward.

As Marks points out, bargain hunters and credit investors should do well today. But I'm worried about anybody who has started investing since 2009.

They're too likely to remain enthralled by highly speculative activity... like buying dips in ARKK or hanging on to meme stocks in hopes of another short squeeze.

So be careful... Whatever made you the easiest money during the last decade could be your worst idea today.

Good investing,

Dan Ferris

Editor's note: Right now, Dan says we're on the verge of a cycle that only comes around once every 50 years... thanks to a rare, specific economic setup. Most investors will be caught off guard by this shift. But if you know where to look, history shows that extraordinary gains are possible. Tomorrow, Dan will sit down with an industry legend to explain everything you need to know... Get the details here.

Further Reading

"Too many investors nowadays still don't understand that they were faking it in the bull market," Dan says. Folks made quick gains in fads and meme stocks – only to take painful losses. That's why it's important to know where real knowledge about the markets comes from... Learn more here.

"The past couple years have taught us that growth does not go up in a straight line forever," Dr. David Eifrig writes. Exciting tech stocks soared for roughly the past decade. Now, the tide is turning. And it favors a group of stocks that investors once ignored... Read more here.