Thursday, January 25, 2018

The Biggest Stock Market Crash "In Our Lifetime"? The Indicators Are All Blinking Red

Image may contain: text that says 'YUTILITY FORECASTER Growth Safety Income Reliability Since 1989 Ari Charney, Chief Inrestmen Strategist You need to rely Why (Regular) Stocks Could on yourself. Drop 50% in the Next 12 Months'
Look, I get that the species of investor governed by irrational exuberance  doesn't want to hear it, but the sky high gains of the DOW aren't going to continue. There will be no DOW 30,000, the market will crash first.  Already the rampaging Bull has lasted longer than all but one other, and in the midst of the gains too many are checking their brains and critical thinking at the assorted investment house doors.  The smart ones understand inflated Bulls always take a dive and the current iteration - with its stratospheric P/E ratios- is already in dangerous bubble territory based on Nate Silver's stats on what precedes crashes.

Silver, in his book, The Signal and the Noise- Why So Many Predictions Fail But Some Don’t  warned (p. 347):

"Of the eight times in which the S&P 500 has increased at a rate much faster than its historical average over a 5-year period , five cases were followed by a severe and notorious crash, such as the Great Depression and the Black Monday crash of 1987”.

Interestingly, two of the largest stock market dives have followed two of the biggest bubbles: the first of 37.85 percent and on the heels of the bubble that formed from Jan. 14, 2000 to Oct. 9, 2002, and the second of 58.78 percent that formed (mainly due to the housing bubble) from Oct. 9, 2007 to March 9, 2009.

More recently, Charlie Farrell, the CEO of Northstar Investment Advisors LLC, wrote a year ago in The Denver Post Business pages  ('Do You Have The Stomach For The Next Stock Crash?') :

"For the past eight years, investors have enjoyed a steadily increasing stock market. Memories of the 2008 crisis have largely faded and many investors have forgotten that sinking feeling. But if you want to avoid the mistakes investors made during the last crisis, you should start thinking bad thoughts. Yes., bad thoughts. Start training your brain and your guts for the next stock market decline. Why? Because big stock market crashes and declines happen and they pose a big threat to your wealth."

One indicator of a bubble is the rate of stock share increase. But another is the rate of inflation related to the trailing P/E ratio.  This is the classic price to earnings which looks at the current price divided by the company's total earnings the past 12 months. .  This is perhaps the most common metric used by investors to value publicly traded companies. While it does not account for growth rates by default, it represents a simple metric that can be compared over long periods of time. 

The  most recent issue of The Utility Forecaster  has tracked this metric up to now and for good reason expresses alarm. We see that the immediate factors have also appeared in 'the biggest dips in recent years" including the 2008 crash. These contributing factors include the Fed policy of cheap money infusion (via low interest rates coupled with quantitative easing or "QE"), along with the Fed subsequently halting QE by no longer buying bonds (from Oct. 29, 2014.) Add to that the Trump- GOP tax cuts which will create enormous deficits and debt and you have the makings of a large potential crash.

For reference, three years ago (in September)  the P/E ratio was about 18.5. Today the P/E for stock in the S& P 500 index is just over 25.  That is, investors are paying $25 for each $1 in corporate earnings. Just before the 2008 crash and 2009 financial meltdown it hit 27. 

What gives?   What gives is that there is no genuine support for the share increases or higher P/E ratio.  In other words, people are basically being hosed. Let's also note the long term average P/E ratio is about 16 and markets tend to revert to that average at some point.

The Utility Forecaster points out that only one other developed  economy adopted a stimulus plan like  ours, and that met with disaster. This was Japan between 2001 and 2006. After the Bank of Japan pulled the plug Japanese stocks fell by 50 percent. What is preventing the current market from crashing now? Mainly corporate stock buybacks which are providing a false cushion.  As long as these corporations keep sustaining their buybacks the DOW (as well as S & P) will continue upward, but there is a limit. Once the debt impact is felt - and it will be, when investors see they are only playing with "Monopoly money", then the roof caves in.

As The Forecaster puts it:

"As reported by Business Insider, a report from the global head of Société Générale's asset allocation team projected that the unwinding of easy money policies and broken politics in Washington will cause  today's market to unravel."

The 'broken politics' refers to an inability to resolve issues like the debt ceiling and out of control spending, especially with inadequate revenue coming in.  The next debt ceiling increase is likely to exceed $21 trillion, and the money still to be unwound from the Fed's QE program is nearly $4 trillion. Put the two together and you are looking at a major catastrophe ready to happen, never mind the current irrational exuberance.

The Utility Forecaster goes on to note that other sources forecast an even more dire end to this Bull, viz.:

"Legendary investor Jim Rogers says we're about to suffer the biggest stock market crash in our lifetime. And he believes it could happen later this year."

The UF goes on:

" Why should we listen to him?  The 74 year old not only helped found one of the most successful hedge funds of all time, he's made a number of market calls including the last housing crash. As Rogers observed, the debt that fueled the last downturn is nothing compared to the debt we've piled up since then. Over the last 10 years our national debt has more than doubled. His advice, 'Be worried!'

He cites a debt of $19.8 trillion but that is before the Republicans effectively added at least another $1.5 trillion with their idiotic tax cuts - the last thing we need now as even Rogers agrees. The most proximate warning metric we have right now? It is the Shiller P/E ratio, which uses inflation adjusted earnings over a trailing 10-year period.

This is "now at its highest level since the bust and even higher than before Black Monday in October, 1987".  We're now at 31.1  by this measure or 85 percent higher than the historical mean of 16.8.  Further, as the Utility Forecaster points out, "the  current total market cap is about 138.2% of the last reported GDP implying that the market is significantly overvalued."

Seth Klarman of the Baupost Group adds this attention getter (ibid.):

"The U.S. financial system is poised to collapse at any time."

In so far as any sensible person knows the national debt doubling in ten years portends a "Potemkin" market,  Klarman is correct.   But I am convinced that "any time" will be this fall, most likely in October, or about 3 weeks before the midterm elections. By then the total uselessness of the GOP tax cuts and their addition to the debt should be realized, and investors will finally see - as the UT puts it -  that their wondrous DOW is based on a straw foundation - now ready to go up in flames.

See also:

Take note, you've been warned.

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