4 min read

The Bear Market's "Trapdoor Scenario"

The Bear Market's "Trapdoor Scenario"

The last time I saw this "trapdoor scenario" play out was in the 2000-2003 bear market. The chart similarities between the Nasdaq 100 index then, and its equivalents today...are striking.

The 2000-2003 bear market had 4 major declines.

  • The peak was in March 2000. In 2 months, the Nasdaq 100 (QQQ) index fell almost 40% before a rebound rally took hold.
  • The second major decline started in September 2000 and lasted 6 months. By April 2001, the QQQ's fell nearly 70%. Yet another rebound rally drove the market 50% higher in 7 weeks.
  • The third phase of the 2000-2003 decline only lasted about 5 months, but it featured the dangerous "trapdoor" I mentioned in the headline.

As that "trapdoor" opened, the QQQs broke below the prior bear market lows, falling 26% in about 2 weeks (with another huge but short-lived rebound rally afterward).

If we compare the chart of today's now-infamous ARK Innovation (ARKK) ETF as a proxy for highly speculative stocks - much like the QQQs back in 2000-2003...the 2 ETFs are practically mirrors of each other, 21 years apart:

click to enlarge

Here below are the same 2 charts, "zoomed in."

Both ARKK today, and the Nasdaq QQQs in 2001, mounted hopeful 6 month-long rallies before fading again.

When that happened in 2001 - the "trapdoor" sprung open, taking the Nasdaq down 26% in two weeks' time (the S&P 500 fell 12% in the same number of days).

I hate to pick on ARKK specifically, but I have important reasons for it.

On Friday a week ago, ARKK closed at an important technical level - its lowest closing price since before the "pandemic panic" of 2020.

So anyone who "bought the dip" back then in 2020 (as millions of new investors did) and "HODL'd" (held on for dear life)...has now watched his/her purchase go from being very profitable to becoming yet another loss.

When we watch big gains slowly dwindle down to a loss...that's definitely a recipe that leads folks to finally "throw in the towel" on their investments.

I don't wish such a thing on anyone - I've been there myself. But the main idea is that - from a contrarian standpoint - when enough folks finally throw in the towel on the stock market, then the market will finally be ready to mount yet another strong rebound rally.

So that's why I think the activity in ARKK is worth all of us watching.

  • The ETF is down 78% since its all-time highs last year.
  • It remains one of the 20 most heavily traded etfs out there.
  • As recently as September, it still attracted inflows of money from hopeful investors making big bets on a rebound in the most-speculative of stocks.

Lastly, ARKK's relatively smooth chart profile makes it a little easier to visually judge the main up-or-down trend. It doesn't have a huge amount of liquidity. So it doesn't have the jagged ups and downs of the S&P 500 or Nasdaq QQQs, where hedge funds and big Wall Street banks can all pile in (or out) at a moment's notice.

Betting on the Next Rebound

But we don't want to lose sight of what we're really here for...which is to make money.

Like a Civil War general (I'll leave it to you whether you want to be General Grant or General Lee)...we want to choose the time and place of our battles - where we take risks, and where we do not.

That's why the goodBUYs portfolio, year to date, is only down about 9%.

So if the "trapdoor scenario" plays out like it did in 2001...we may have an edge in betting on a strong rebound, and salvage some good gains in the last 2 months of the year.
Click to enlarge

Lastly, let's remember that bear markets are always "terra incognita"...unfamiliar land. As much as someone like me points out how one bear market 21 years ago is similar to the one we're in now...nothing is written in stone.

All we can do (as I keep saying) is try to make smart bets...

We maximize those bets for bigger gains when it looks like we're correct, and minimize those bets to limit our losses when we're wrong.

Jeff Yastine