Will this ‘rally of rubbish’ trigger a stock market crash?

Today, I think investors are partying like Christmas 2021. At that time, the S&P 500 and Nasdaq Composite reach a fresh daily high. But what happened next was the biggest stock market crash since 2008.

Stock market crash, part 2?

The stock market has risen sharply since its lows in October. The S&P 500 reached 3,491.58 in 2022 on October 13. On Friday, it closed at 4,136.48, jumping almost five times (18.5%) in four months.

The Nasdaq Composite has risen from an October low of 10,088.83 to close at 12,006.96 on Friday. The 19% gain is almost the same as the S&P 500.

I thought US equities looked cheap at the time and my husband bought six mega-cap stocks for our family portfolio on November 3. But I was surprised by how far and how quickly the market has rebounded. Unfortunately, I smell trouble ahead – and possibly another stock market crash.

To me, this is a ‘trash rally’

What worries me is that unhealthy speculation has returned to the market in 2023. The irrational exuberance of 2020/21 has pushed the prices of stocks, bonds, property and digital assets into bubble territory. By the end of 2021, I have repeatedly warned that this ‘whole bubble’ will burst, causing a stock market crash.

When the market crashed last year, my husband and I lost money, but much less if our portfolios weren’t prepared for the crash. And when asset prices rise again, I’m sure this ‘run for junk’ will stop.

Predictably, the most speculative asset, beat and meme stocks have soared during this latest bounce. For me, the benefits of these risky assets are not equal to the company’s bottom line and the wider economic reality.

For example, this table shows the outsized returns since the end of 2022 of six volatile stocks, plus Cathy Wood’s most popular exchange-traded fund, and the #1 cryptocurrency:

Note that this large return has arrived in less than six weeks of 2023. For me, there is no rational explanation for this bumper benefit. Meanwhile, the iShares MSCI ACWI ETF up 8.2% in 2023 – a global benchmark that this booming bubble asset has surpassed by miles.

Crazy retail and short coverage

Basically, there is no explanation for these benefits. Option-led short-term trading and outright gambling seem to have contributed. US investment bank Goldman Sachs reckons that the surging market has forced short-selling hedge funds to cut shorts. When a bet on a stock goes bad, the fund goes ‘short covering’ (buying back the stock to prevent losses).

Obviously, other elements in what Financial Times editor called this “flight to [expletive deleted]“ are retail investors betting on bombed meme stocks and crypto-based assets. For many, this ended in disaster in 2021/22. In my opinion, it is likely to happen again. And while the biggest losers in 2022 might be the biggest winners this year, I wouldn’t bet on that.

On a more positive note, I don’t expect this speculative trading to lead to more stock market crashes. However, while some junk will crash, the broader market should appear unscathed. But I avoid any wild wagers now by only buying quality stocks!