In March 2020, as the stock market gingerly crept back up after the huge Corona Crash, I said investors should beware of a “double bottom” … a second big pullback.

I was wrong. Plenty of my commenters on my YouTube channel are still making fun of me about that.

Except for a couple of big drops around election time, the Federal Reserve’s monetary support kept the stock market soaring.

Maybe I was just premature.

By several measures, the stock market is in its worst shape since March last year.

For example, CNN Business’ Fear & Greed chart is in “Extreme Fear” territory:

CNN Business’ Fear & Greed chart

(Click here to view larger image.)

Volatility, new 52-week highs, the options trade and market breadth are the worst they have been since then as well.

And then there’s the bond market:

2021 bond market volatility

(Click here to view larger image.)

What a difference a couple of months makes!

Not too long ago, inflation terrified markets. Ten-year treasury yields were pushing 2%. Now they’re back down to 1.17%.

That means the big money is fleeing stocks and turning to the safety of bonds.

Every stock in the Dow industrials, transportation and utilities indexes was plunging as I wrote this. Industrial commodities, energy and financials were all tanking.

What’s going on?

More importantly, what should you be doing right now?

We Were Warned

I’ve been saying for months now that in a speculative stock market, external factors determine price moves. Fundamentals count for little.

In such a market, when all the news is good, stocks all go up at once. But it only takes a couple of bad headlines for it all to come tumbling down.

That’s what happened yesterday.

The bad news, of course, is the Delta variant of COVID-19.

Cases are up 140% in the United States over the last two weeks. Deaths are up 33%. Most of the latter are amongst the unvaccinated, particularly in Missouri and Arkansas.

New cases are skyrocketing in western Europe and Russia. Three of my fellow South Africans have tested positive in Tokyo’s supposedly safe Olympic bio-bubble.

Particularly alarming to investors, authorities in some jurisdictions are re-imposing mask mandates. Cities such as Sydney, Australia are in full lockdown mode. Olympic city Tokyo is in a state of emergency.

Worst of all, even fully vaccinated people can get the Delta variant. Although they almost never get sick, they can pass the disease to the unvaccinated.

Evidence of COVID-19’s resurgence has been building for several weeks. Last week was the first down week for the market in a month. Monday, the negativity turned into a waterfall, as the S&P 500 plunged straight through its 50-day moving average.

But the real evidence of Delta’s destructiveness is in the Dow, which fell off a cliff yesterday morning:

delta variant stock market volatility dow jones

(Click here to view larger image.)

The Dow, of course, is where companies associated with “reopening” live.

Monday’s price action is an unmistakable signal that in the space of a week, the market turned 180 degrees away from fears that the economy will run too hot, to fears that it will run too cold.

I Saw 50% of This Coming

Between September last year and June, I closed 16 positions in my Profit Switch model portfolio for an average gain of 103%. I knew those gains were likely to evaporate in the coming months.

I was dead right about that.

Based on the information available at the time, my colleague Clint Lee and I decided to rotate those gains into companies likely to benefit from a resurgent economy. Those included basic materials, chemicals, entertainment services and construction. Unfortunately, those stocks were hammered yesterday.

Of course, there was no way to know ahead of time about the Delta variant.

And I’ve long expressed doubts about the Democratic Party’s ability to pass a big infrastructure bill, but I had to take a chance on it.

That’s cold comfort if your portfolio is in the red.

A Reason to Stay Smart and Tough

Clint Lee reminded me yesterday that the market has gone longer than 300 days without a 5% or greater pullback like those in the chart above. Usually, they happen about twice a year.

That means the market was due for a pullback like the one we saw yesterday. But pullbacks are never permanent.

Three weeks ago, I said in Bauman Daily that, based on history, we are only halfway through the current secular bull market phase. I pointed out that during the excellent bull market run of the 1990s, a series of big pullbacks punctuated the market’s overall rise:

stock market growth 1992-2000

(Click here to view larger image.)

I called those dips “shakeouts.” In each one, weaker hands sold their stocks while stronger hands held on to reap the gains of patience.

Smart investors know that. As Warren Buffett put it, the stock market is “a mechanism for transferring wealth from the impatient to the patient.”

History proves Buffett correct. The evidence is there for all to see. Don’t ignore that evidence.

Let it make you smart … and tough … so you can be one of the strong hands who holds through the shakeout to emerge richer on the other side.

Kind regards,

Ted Bauman
Editor, The Bauman Letter