The Bigger the Stock Bubble, the Bigger the Crash

The S&P500 did it again, this time inching up by 0.4% on low volume. Volatility remains stuck at multi-year lows. Complacency reigns as most everyone believes, incredibly, that the stock market simply cannot go down because the Federal Reserve will not allow it to go down. Incredible.

On Main Street, things are not so rosy. After spiking substantially over the last six months, interest rates are finally starting to hurt the US housing market. The housing market index disappointed last week, as did existing home sales, both of which missed expectations. While retail sales, ex-autos, came in slightly stronger than expected, the Philly Fed survey and the PMI manufacturing index both missed. Inflation, both consumer and producer, remains tame; this is not consistent with a strong economy, which continues to merely limp along, having never returned to pre-financial crisis growth rates.

To say that the S&P500 is over-stretched is an understatement. Over the last several months, the index as a whole is starting to look like it’s going parabolic, and doing so when almost all of the long-term fundamentals of the US economy are not doing so well.

Yes, unemployment looks like it’s gone down, but that’s only because millions of unemployed people have dropped out of the workforce, many of them permanently. Real median wages have been falling, and they’re still falling. Food stamp enrollment has almost doubled over the last five years; almost 50 million people in this nation of 307 million are on food stamps. Home prices, after being pumped up by cheap money from the Fed over the last couple of years, are stalling; soon they could start to fall again. Corporate profits are stalling, at best. At worst, they’re starting to fall across many sectors.

But stock prices are rising, seemingly without an end in sight, as the multiple of stagnant earnings creeps higher and higher.

Interestingly, it’s been over two years since the S&P has fallen, if even briefly, by over 10%. The cyclically adjusted PE for the S&P, at 25, is now above levels where all (except the tech bubble) bear markets have started since 1929. And the ratio of the value of all US equities to the US GDP is near record highs.

In no way does this mean that stock prices can’t rise further. Something similar happened in the late 1990’s and stocks kept climbing for another two years.

But in the end, the same thing ALWAYS happens. The more stock prices deviate from their historic long-term averages, the more they correct—eventually—to these averages.

So if stock prices continue to melt up from here, then the pain that follows will be all the more severe. All these gains, and then some, may be lost in a matter of weeks or months. It took the S&P about five years to reach a record high in 2007 after losing about 55% in the early 2000’s. But it took only 15 months f or the S&P to lose 58% in early 2009.

Today, studies show that less than 15% of investors are bearish. So even assuming that you’re one of the smarter and faster ones, meaning you’ll know when to sell and will sell ahead of the crowd, to whom exactly will you sell…..when everyone who could  be a potential buyer of your stocks is already in the market and looking to sell as well?

This will end badly, There is no question about it. The only unknown is the timing.

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