When Will the Stock Market Crash Again?
The US Stock market and the economy in general are headed for a crash, and this is coming in the not so distant future.
Now the stock market has had quite a run since it’s low in 2009 and mainstream pundits are quite happy to keep selling you the illusion that his trend is going to continue indefinitely. But the reality of the matter is that it cannot continue, at least not for very much longer. What we’re witnessing is a bubble. A bubble that has been inflated through the Federal Reserve’s quantitative easing policy and market sentiment, not fundamentals.
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So, what are we talking about here? What is quantitative easing and what does it have to do with the stock market?
The Federal Reserve is engaged in 3 rounds of money printing, or quantitative easing as they like to call it, since the crash of 2008. QE1, QE2, and now QE3. Unlike QE1 and QE2, QE3 which has been underway since 2012 doesn’t have a time limit. It will keep printing until the fed decides to end it, and no one is willing to say exactly when that’s going to be. During QE3 the Federal Reserve has purchased 85 billion in dollars mortgage-backed securities and treasuries each month. These mortgage-backed securities are comprised of home mortgages bubbled up and resold as investments; these are also the same toxic assets that set off the 2008 crash.
It sounds really technical and most people’s eyes will glaze over when they hear stuff like this but what it comes down to in simple terms is that the Federal Reserve is bailing out the banks by propping the price of these bad investments. We couldn’t have the banks paying up the consequences of their own mistakes now could we? The official motive for this policy is to prop up the economy so that it can recover, but in practice this is just welfare for the super rich. The evidence for this is easy to find. The number of US residents living in poverty has risen since 2012. It’s now up to 46.5 million people, according to Reuters. This while the stock market has been booming. Why?
Because QE3 has led to record profits for the banks, and banks don’t let extra money sit quietly in accounts, they invest it in the stock market. And as money flows into the stock market, prices rise. Whoever owns the most stocks, benefits the most from this increase. And who owns the most stocks? Well that would be the wealthiest segment of the population. Stock prices have climbed steadily since 2009 reaching new highs in recent months. As usual, rising prices feed investor enthusiasm and people started believing that the party would never end. It’s a recovery! America is making a comeback! Just one problem, this party is running on 85 billion dollars of funny money that’s being injected into the system every month. Sooner or later the fed is going to have to pull back. No one is denying this, not even the fed. Most marketing analysts believed that in September of 2013, QE3 would be slightly reduced or tapered off and as a result there was a sell off leading up to the announcement. However the fed decided not to slow down the printing presses at all, QE3 will continue. Markets rallied quickly after the announcement but then they stalled.
This is without the fed actually making any changes, so clearly investor sentiment is playing a huge role here and that sentiment is vulnerable. Now there’s no way to predict the future with 100% certainty, but there are a number of indicators that point towards a massive downturn in the market at the end of 2013, or early 2014. One of the first warning signs has been the exit of insiders from the market.
The Sentiment Trader’s Smart Money/Dumb Money Confidence Index tracks what the insiders are doing versus what the average investors are doing, and this index shows a sharp divergence developing between the two.
Of course, insiders aren’t going to advertise this kind of thing because they want to get their money out before mad rush to the bottom starts. Why would the smart money be pulling out of the stock market? Well because they understand that markets run in cycles, and bubbles always pop eventually.
According to Ned Davis Research there were 33 bull markets from the beginning of 1900 until March 2009. The average length was 2.1 years. Only 5 of those 33 bull markets lasted longer than that. The current bull market which began in 2009 is almost 4 and a half years old. If this market was natural it would have had a crash at some time ago. However this market is not natural, it’s being propped up with 85 billion dollars of funny money per month. Now of course there are a lot of people who are emotionally and financially invested in this market who will point to the fact that by most indicators it’s still strong.
However if you look at charts from previous bull markets leading up to crashes you’ll see that this is to be expected, markets always look best right before the fall.
Look at charts showing the stock market leading up to the 1987 crash, the collapse of the dotcom bubble in 2000 and of the housing bubble in 2007.
To make this a bit clear let’s look at the 2003-2007 chart alongside the 2009-2013 chart.
According to Carter Braxton Worth, chief market technician at Oppenheimer Asset Management. the correlation between these two charts is 95.5%.
Another metric to look at while assessing the likelihood of a market crash is the Shiller price to earnings ratio.
Price to earnings ratio is the ratio between the price investors are paying for stock, and the actual earnings for the companies in question. When you see the price to earnings ratio rise this means there’s a growing disconnect between the stock price and the actual earnings. There are a number of variations in the price to earnings calculations, but the Shiller calculation has consistently shown the same thing as markets are getting ready to crash. The stock price goes up dramatically without a corresponding rise in earnings. If we look the Shiller price to earnings ratio we see that it’s been rising dramatically since 2009. And right now it’s about to hit a resistance line where crashing usually occurs.
Does that mean that a correction is guaranteed to happen right away? No. One thing that’s really important to understand right here is that markets aren’t just driven by numbers, sentiment plays an enormous role. The numbers point towards underlying vulnerabilities that are exposed when market sentiment changes. Since 2009 the fed has been inflating a bubble of epic proportions. That bubble is going to pop it’s just a question of what will trigger the crash. The Federal Reserve is in a bit of a corner here. They understand that if they cut back on QE3 in any significant way the bubble will burst. Bernanke knows this and that’s why he’s stepping down. He doesn’t want to be in office when the consequences of his policies come home to roost. They want to delay this as long as possible because if it bursts right after a change that they make, they’ll obviously decide on who to blame.
However even if they don’t pull back on QE3, any major crisis that hits on the coming months will wreak havoc on market sentiment. And this will trigger a correction. In such a scenario, the official line will pin the blame on the event that sets the downturn in motion, rather than on the bubble itself. We saw this after 9/11 which knocked the last bit of wind out of the dotcom bubble, even though that bubble was already unwinding. This was convenient because almost no one put any attention in who created the bubble in the first place. Regardless of what triggers the correction, or there’s an external event or a pull back from QE3 and regardless of whether this happens in the next few weeks or months, the crash is coming.
The fed will of course attempt to intervene, however they really have 2 tools at their disposal: The ability to lower interest rates, and the ability to create new money. Interest rates can’t really be lowered any more, and the fed is already pumping 85 billion into the economy every month. Will it really have a significant impact if it doubled down amongst QE4, injecting say 170 billion each month? In the context of a mass sell off, that’s awful. There’s a law on diminishing returns when it comes to printing money, even if you do control the petrodollar and the world reserve currency status. It’s like a drug addict whose tolerance has been increasing even as their body’s reaching the breaking point. To influence the outcome this time, the fed will have to go for broke, and this could easily lead to an overdose.
The real blast won here is how the international community reacts to fed policies. We already see the bank of international settlements calling for an end to the fed’s money printing. And there are signs of currency warfare. Throw a little physical war into the mix and you’ve got yourself a really dangerous cocktail. If instead of ending QE3 the fed adds to it, as they would in the event of a crash, then we’re opening up Pandora’s box and at that point all bets are off.