BALTIMORE – When we left you yesterday, we were describing why the situation is getting dangerous for investors, and how the lessons learned over the last 30 years may backfire in the next crisis.
“Dow over 26,000… bitcoin under $10,000,” reports this morning’s news… “but could crypto panic spill over into stocks?”
Investors are accustomed to depending on the Greenspan-Bernanke-Yellen Put… which is to say, they are pretty sure that the feds will come in with more booze when the party starts to flag.
“Buy the dip,” they tell each other, confident that the feds can be counted on in a pinch.
Many think the recently passed tax bill is 80-proof, too – sure to rev things up by putting more money in the hands of shareholders and consumers.
Maybe it will raise stock prices. Or maybe it won’t. What it won’t do is make the next crisis disappear.
We hate to be the bearer of bad tidings, but bad tidings are all we have to bear.
Corporate America is already pretty flush. The price-to-earnings (P/E) ratio for the S&P 500 is now 70% above its long-term average.
In fact, the price of stocks relative to earnings has only been near this high three times in the last 118 years… each time caused by the aforementioned Fed party favors.
And if stocks go higher, it merely gives them further to fall.
In order to get back to more traditional levels, notes Martin Feldstein in yesterday’s Wall Street Journal, the next bear market would have to wipe out some $10 trillion of stock market wealth.
This, he says, would take 2% off annual GDP… tipping the country into recession.
How close is this crisis?
We turn to our Doom Index, put together by our ace researcher, Joe Withrow:
The Doom Index spiked back up to “7” this month – our extreme warning level.
After a surprisingly expansive third quarter in 2017, credit growth fell back to 1.6% in the fourth quarter. Paraphrasing your friend and economist Richard Duncan, bad things happen when credit growth falls below 2%.
Looking at the credit markets, corporate bond downgrades continued to come in at an elevated level last quarter. And junk bonds are starting to show some cracks, falling more than 1% on the quarter. That said, junk bonds still closed out 2017 in positive territory.
Stock valuations are still high relative to their historical averages. But we still haven’t really seen the spike in “animal spirits” that we usually see at the end of each bull market.
But that is starting to change. Investor bullishness spiked by more than 20 percentage points last quarter, as measured by the American Association of Individual Investors survey that we follow.
Our financial metrics were the first to scream warnings at us back in 2000 and 2007… but the markets did not crash until we started to get warnings from our productivity metrics also. I suspect that will be the case this time around as well… But you can never know for sure.
What you can know, however, is that we are much closer to doom today than we were last quarter. Might be a good idea to dust the old Crash Alert Flag off… Make sure it looks presentable.
We’ve hung out the old black-and-blue Crash Alert flag so often – and without effect – that both it and our reputation for market timing are in tatters.
We’re reluctant to expose either to further ridicule now.
But a bear market is inevitable. We recall the 1970s…
It was in 1973 that the Dow first crested above 1,000. Then, it went down… and didn’t get back to 1,000 for another decade.
During that time, the ‘70s, “nominal” stock prices – without accounting for inflation, that is – went down, but never by more than about 25%.
The damage didn’t seem so bad. But consumer price inflation was also steadily eating away at “real” (inflation-adjusted) values. You can see what really happened by looking at the Dow in gold terms.
The peak occurred in 1965, when it took about 25 ounces of gold to buy the Dow stocks.
Then, stock prices fell… down… down… down – to the point where you could buy the entire Dow with a single ounce of gold.
In real terms, stocks had lost 96% of their value.
We see a similar debacle coming. The Dow sells for 20 times the price of an ounce of gold – below the level of ‘65, but higher than the level of ‘29.
Central banks are raising rates. Inflation seems to be picking up. And the feds have huge deficits to finance.
The bond market is going to be squeezed between more supply and less demand. Bond prices will fall as yields rise. Yesterday, yields on the 10-year Treasury rose to 2.58%, up from a low of 1.40% set in July 2016.
Stock prices will fall, either because of rising interest rates… or in spite of them. Expect initial losses of about 50%.
Then, once again, investors will turn their lonely eyes to the Fed.
Ready… aim… fire! The artillerymen at the Fed will give the order. But the shot won’t be heard all around the world. Instead, it will barely be heard at all… because the Fed is out of powder.
As Mr. Feldstein explains, the Fed waited too long to begin raising rates. In a crash, it will want to cut rates. But unless the crisis waits another two years, it will have almost no rates to cut… and no monetary stimulus to offer.
What about fiscal stimulus, you ask – more deficit spending by the government?
Ah-ha… that’s what the tax cut is supposed to be. In effect, while the Fed was too late… Congress fired its cannon too early – even before the enemy appeared on the scene.
And now, when the next crisis arrives, it will be almost impossible to pass another tax cut or spending increase… or finance more deficits… without driving up rates and making the situation worse.
But wait… what’s that? Reinforcements!
Tune in tomorrow.
By Jeff Clark, Editor, Jeff Clark’s Market Minute
Parabolic moves always end badly.
It doesn’t matter what the argument for the move is. When the price of an asset moves straight up, and is accompanied by a huge burst of bullish sentiment, the rally is not sustainable. It pretty much always ends with a downside reversal that erases the gains as quickly as they were achieved.
That’s my concern with the broad stock market right now. The S&P 500 is up 5% since the start of the year. It has been a one-way move higher. And it looks to me like a parabolic move.
Here’s the chart…
When this move finally corrects – and it will at some point – then the S&P has a risk of a decline all the way back down to where it started the year at 2,673. That lines up with the 50-day moving average line (in blue), and it’s a reasonable area to support the market.
That’s not a big move lower. We’re talking about erasing just the gains of the last three weeks or so. That shouldn’t cause too much damage for most investors.
But for folks who’ve been chasing this market higher in the face of overbought conditions, even a 5% decline from current levels will be painful.
Now, I can’t tell you when this current rally will end. I thought it would have run out of fuel by now.
But I do know a parabolic move when I see one. And the S&P 500 is in the midst of such a move.
These sorts of moves always end badly. And the resulting decline usually gives back all of the gains. So I expect we’ll see the S&P 500 trade back down below 2,700 or so in the coming weeks.
Most traders would do well to be a bit cautious right now. The next few days could be rough for the bulls.
– Jeff Clark
P.S. My goal with the Market Minute is to help traders get ready for their trading day, whether stocks are poised to move up, down, or sideways.
To start receiving the Market Minute at 7:30 a.m. ET every weekday – so you can know what trades to make long before the opening bell rings – click here.
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You are as bigoted as Trump. You never mentioned the Italian wave, the Indian wave, the Muslim wave etc. The Irish are among the richest Americans.
– Robert D.
For a well-educated man, your lack of knowledge is amazing. Didn’t you hear the story that explains government as a child? It goes something like this:
The King wanted to go out riding with the Queen, so he asked the royal weatherman what the weather was going to be. “Sire, it will be sunny and pleasant all day,” was the reply. So the King and Queen mounted up and sallied forth (or fifth, I can’t remember).
As they rode down the lane, they came upon a man riding a donkey. When they mentioned the nice weather, the man stated that it would be raining hard within half an hour. Puzzled by the man’s comment, the King and Queen continued their ride, until suddenly, the skies opened and they were both soaked.
The King and Queen hurried back to the royal abode and the King called for the royal weatherman. “You are fired!” yelled the King.
The King then sent a courier to find the man riding a donkey. When the man showed up with his donkey, the King said, “You have great knowledge about the weather. I want you to be the new royal weatherman.”
“Sire,” the man replied, “I know nothing about forecasting the weather. I simply look at my donkey’s ears and when they droop, I know it will be raining within half an hour.”
The King told his chamberlain, “Hire that donkey as the new royal weatherman,” which was done immediately. The results were so good that the King set this example as the new hiring policy.
It continues to this day.
– Bill C.
I read your daily missives with eyes wide open. Somedays, I nod in agreement. Other times, I shake my head in disbelief, and occasionally throw up my hands in disheartenment at your words. I think of you as neither a sage nor a dullard. Just one person relating his insight or opinions and not really caring what others may think.
That is until I saw your Diary of 1/10, in which you put on full display how thin-skinned and insecure you truly are. To have to resort to printing 17 (seventeen) letters in support that you “are right” is beyond anything I could have imagined from you. Your cachet with me has dropped considerably. What I liked about you, and what I like about Mr. Trump, is the attitude of “I don’t give a rat’s behind what you think. This is where I stand.” I will continue to read you and maybe, in time, I will regain the respect I once held for you.
– Joseph T.
Meanwhile, yesterday’s “Stocks Could Fall 80% From Here,” has sparked conversation…
You have been looking for a fall of 80% for years. Why don’t you get into another business?
– Joseph C.
Great and timely piece! As a 26-year veteran of the industry, I can say you are, once again, spot on. I recently had a former customer – currently a hedge fund manager – try to pitch me on a “melt-up.”
In my mind, it’s not going to happen unless the Fed wants to dump another $10 trillion on the market. And I don’t see that happening. I think the governors quietly realize they’ve already created a monster that they can’t tame with loose money. Quality gold and silver mutual funds are probably a great place to be right now.
– Stephen B.
Cryptocurrencies are sinking.
But Jeff Brown, Bill’s top technology analyst, isn’t worried. That’s because he’s found a way to profit from the cryptocurrency explosion without ever purchasing bitcoin. Read on here.