That Roller Coaster Feeling
We’re watching a trash rally in real-time. History tells us these episodes end badly – the pattern is consistent enough.
The challenge? No one can accurately time the ending. Trash rallies run weeks, months, or even years longer than rational analysis suggests. They also typically deliver their biggest returns just before everything falls apart.
So how can we best stay invested while protecting ourselves from the worst indulgences? If we live in an uncertain world, then how trash rallies end is also more probabilistic than known. Here are the most typical resolutions:
Scenario 1: Correction and Resume (~30% probability)
We believe this is the scenario we’re currently experiencing.
Markets drop 15-25%, shaking out weak hands before the rally resumes. Similar to 1998’s LTCM crisis or early 2016. Most dangerous for conservative positioning – quality suffers the downside, then watches trash rally ahead again.
Scenario 2: Rolling Crisis (~30% probability)
Problems emerge progressively from early warning areas like crypto exchanges, overleveraged firms, and spreading credit events. Like 2007-2008, where cracks appeared over 18 months before the system broke. This rewards patience and cash reserves.
Scenario 3: Soft Landing (~20% probability)
Speculation moderates gradually without a crash. Quality catches up as earnings reassert themselves. Not seen since the mid-1990s and may never recur as our economy has shifted materially.
Scenario 4: Rapid Collapse (~20% probability)
A trigger event causes violent unwinding. Markets fall 30-50% quickly like March 2000, October 2008, or March 2020. Quality suffers initially but recovers within 1-2 years as trash mostly vanishes.
Reliable Warning Signs
Despite our inability to time these events, we can monitor good indicators:
- Credit Spreads (Normal) – Widening between corporate and Treasury bonds signals stress. Currently at reasonable levels.
- Margin Debt (Elevated) – Record borrowing to buy stocks amplifies downside risk. Near historic highs but stable.
- Valuation Extremes (Warning) – When unprofitable companies trade at 50x sales. Many stocks at extreme multiples.
- Volume Patterns (Normal) – Declining participation as prices rise suggests exhaustion. Participation remains broad.
- Sentiment Indicators (Elevated) – Extreme optimism historically precedes corrections. High optimism, low fear currently.
- Sector Rotation (Warning) – Money flowing from quality to speculation accelerates rallies. Currently seeing speculative flows.
Our current assessment: Mixed signals with elevated speculation. No systemic crisis building, and we’re monitoring closely for changes.
Practical Positioning
We follow certain steps to prepare for what we know is coming despite showing few signs of landing soon:
Structure:
We never abandon quality stocks for speculation. Instead, we screen for favorable opportunities we expect to lag the rally and recover faster in most cases.
We emphasize strong portfolio diversity, requiring at least 6 independent factors to explain our results, and allocate to short duration fixed income that gives us flexibility when prices correct.
Portfolio Design:
We target portfolios less volatile than the stock market (typically 22% less for our flagship strategy) where we also believe we can overperform.
By holding stocks across all eleven economic sectors and tilted toward top performing sectors, we achieve very strong diversification in about 22 stocks. Then we mix in about 35% fixed income that either matures within a couple years or resets every three months with the goal of drafting a trash rally like a NASCAR driver reasonably close behind.
When the inevitable correction lands, we expect to be better positioned for the decline and expect to recover faster when our fixed income gives us money to buy bargains in the rubble.
The Psychological Challenge
Here’s the hardest part: watching others make money while we’re defensive.
Performance reports showing garbage outperforming quality typically trigger increased social media posts with screenshots of massive gains and champagne celebrations in penthouses.
It can be humbling watching rockets blast past you when you’re still driving a very good vehicle. We rely on deeper analysis to tell us whether these rockets are time bombs with engines or an actual market shift we need to catch.
Action Steps for Individual Investors
Honest Portfolio Assessment – Categorize holdings as core quality, acceptable speculation, or pure garbage. If you can’t articulate why you own something, beyond “it’s going up,” that’s likely garbage.
- Take Speculative Profits – Like any good Las Vegas money manager, put a portion of winnings aside each quarter because all streaks end.
- Establish Strict Exit Rules – For any speculative position, write down time limits, price targets, and stop losses and stick to them.
- Build a Shopping List – What quality companies would you love to own if they were 30-50% cheaper? Have target buy prices ready.
- Maintain Adequate Cash – Aim for at least 10-15% (we target at least 35%) in short duration fixed income. High quality, short duration doesn’t lose 50% when markets panic.
- Don’t Leverage Now – Imagine how margin feels if positions fall 30% and your broker calls. Leverage amplifies mistakes.
The Ultimate Brag
Do we want to feel smart for six months, or build wealth over 30 years?
Trash rallies reward short-term speculation whereas long-term wealth comes from consistently buying quality at reasonable prices and staying invested through cycles.
For us, a nicely compounded account and a better ride through our lives is the ultimate brag.
Stay Frosty Out There
We’re in a trash rally. We know how these historically end and we can position to survive the endgame. If we manage it well, we’ll find opportunities in the carnage.
Our probabilistic framework suggests defensive positioning makes sense now, even if we are in a Correction and Resume scenario that is most dangerous for conservative investors who missed the rally up. We expect a bumpy ride similar to the 1999-2000 run for internet companies without the same degree of carnage. In that rally, there were several drops and rally resumptions before the final cliff.
Remember:
- Quality is almost always cheap relative to garbage over time;
- Cash provides dry powder for resulting opportunities; and
- Discipline preserves capital.
However this rally resolves, we want to benefit rather than recover from carnage.
How are you positioning for the potential end of this trash rally? Are you maintaining discipline or tempted to chase speculation? Share your approach below – we’re all navigating this together.
IMPORTANT DISCLOSURES
This article is for educational purposes only and does not constitute investment advice. Past performance does not guarantee future results. All investing involves risk, including potential loss of principal.
The scenarios presented are hypothetical illustrations based on historical patterns and should not be considered predictions of future market performance. Probability estimates are subjective assessments based on historical analysis, not quantitative forecasting models.
Market timing is extremely difficult, and even correct long-term analysis can result in significant short-term underperformance. The strategies discussed may not be suitable for all investors and should be evaluated based on individual circumstances, risk tolerance, and investment objectives.
References to specific investment strategies or positioning represent current thinking as of November 2025 and may change without notice. These should not be considered recommendations to buy or sell specific securities.
LUL Wealth Management is a registered investment advisor. Registration does not imply a certain level of skill or training. More information about our firm’s investment advisory services can be found in our Form ADV Part 2, available upon request.
Consult with a qualified financial advisor before making investment decisions based on this analysis.