Warning: Stocks Likely to Crater from Here

I don't relish the job of constantly pointing out the risks to the equity markets. But since few on Wall Street seem willing (or able) to do this, I'm "making the call" for a market correction, as enough variables have aligned to indicate a high likelihood of stocks heading downwards from here.

I've only given one other such warning about equities before, and that was in March of 2008, when I warned of the possibility of a 40% to 60% decline in stock prices by Fall. I am making a similar call today, with the understanding that I am usually a bit early to the game with my views.

Before I get into the details, the broad outline is that I see a case where speculative fevers, propelled by the Fed's $85 billion thin-air money printing program, have more or less run their course, with the Dow and S&P indexes stalled near their all-time highs. That is, $85 billion a month is what it takes to merely keep the Dow near 14,000 and the S&P 500 near 1,500.

On a fundamental basis, I see numerous signs of consumer weakness, political in-fighting and paralysis in DC, high insider selling, and the return of the retail investor (a.k.a. "greater fool") to the stock market. 

On a technical basis, there are numerous tell-tale signs of a market top, including too much bullish sentiment, waning momentum on multiple timeframes, and too many NYSE stocks being above their 200-day moving average (at least until recently; that's begun to correct).


Triple Top?

The S&P 500 and Dow Jones are both once again near all-time highs…for the third time.  The old saying third time’s a charm can work both ways when it comes to the stock market.  Sometimes an index will bust through to new highs, and other times it will fail spectacularly crashing to new lows.

We should all be watching the behavior of the major indexes here, because the possibility of a major triple-top failure is quite high, for reasons outlined below.

If the S&P 500 fails at the triple top and breaks down, from a charting perspective the next thing for it to do is revisit the bottom and then make up its mind as to what it wants to do next.  The implication here is that a major failure of the S&P 500 will open the possibility of it revisiting the 600-800 level, or some 45% to 60% lower from the 1,500 level where it currently churns.

It will take some time to get to that level, typically 3-6 months, unless there’s some sort of financial accident to hasten things along, in which case it could all be over in a month or two.

Assuming a failure at the triple top, we’ll just have to watch and see what the market wishes to do once it plumbs the bottom once again.  For now, the daily and weekly charts of the S&P 500 show waning momentum, and the weekly chart remains in overbought territory (green lines and circles):

These overbought and slumping momentum indicators are headwinds to the Fed’s efforts to keep the stock market elevated. 

From a historical standpoint, stocks are cheap when they sport a collective p/e in the high single digits.  Currently they are anything but cheap on that basis. 


With a current p/e of 22, the S&P 500 is on the expensive rather than cheap side of things, and is roughly 35% above its long-term average and more than 100% above what we could legitimately call 'cheap.'

The summary here is that if stocks do indeed retreat from here, a triple-top failure will deliver quite a punishing blow to the current efforts to repair the public’s trust in the stock market as a place to send their hard-earned savings to grow.  It would be quite difficult to engineer a run at a fourth top, given the importance of retail participation in providing fuel for the rise of stocks especially given that the boomers are retiring at the rate of 10,000 per day and drawing upon their investments instead of adding to them.

The younger generation(s) have been the main victims of the high unemployment and general wage stagnation that have been the hallmarks of the Great Recession.  It is not likely that they will be able to save and invest at a rate equal to the boomer's withdrawals, creating one more equity headwind for the Fed to overcome.

Sell in May and Go Away

Of course, another old adage that applies to the stock market is sell in May and go away, which has proven to be a remarkably effective strategy over the years.  The average return between May and September is -0.5%, while it is over 12% for the rest of the year.


Why this yearly vacillation of returns occurs is open to speculation, but a betting person would have to think long and hard about buying stocks here with May approaching and the Dow and S&P at all-time highs rather than staying on the sidelines and then buying back in September or October if one was so inclined.

However, given the macro forces at play at this time, this May-to-September period could easily offer much more dramatic losses than 0.5%.  I am personally thinking as much as two full orders of magnitude greater, as -50% is right in the middle of my target window for losses.

As always, the best time to begin repositioning one’s portfolio is before any big moves get underway, so I personally would not wait until May to make adjustments, assuming one was of a mind to do so.

Whether or not you forego selling stocks, lighten up your positions, or take on some form of portfolio protection in the form of puts or inverse ETFs, these seem like good things to do before April is over.

Danger Ahead

Technically stocks are overbought. Fundamentally, the picture is even worse: they are facing a litany of economic drags (including weakening GDP growth, higher taxes, the impact of Obamacare, sequester cuts, high gasoline prices, chronic unemployment, etc.) and robust insider selling.  We explore these fundamental risks and their likely impact in great depth in Part II.

For all of these reasons, equity markets face a very high chance of falling over 40% between now and fall of 2013.  (Yes, I'm aware of how extreme a price prediction this is.)

While there’s always a chance that the Fed can keep things magically elevated and they’ve done a very good job so far –  it is my view that they cannot do this for much longer without a serious correction to justify an even larger program of overt and covert intervention. 

In Part II: How the Market Failure Will Happen, I detail how the pattern I expect to see will play out and why I expect the fall in equity prices to happen within the May-September window.  This downdraft will be characterized by lots of volatility, formed by market routs and Fed-inspired rescues, alternating until some form of bottom is reached.  Along the way there will likely be a flight for "safety" into the dollar and Treasury paper, but only during the first stage of the next crisis.

Once a bottom is reached again, this might be anywhere from 40% to 60% lower than the current ~1500 level on the S&P 500 the process will begin to be dominated by rising government borrowing, which will cause interest rates to begin to rise. 

When that happens, expect capital to flee the paper market for hard assets.  In particular, that's when the upwards price revolution in the gold and silver markets will kick into high gear.

Click here to read Part II of this report (free executive summary; enrollment required for full access).

This is a companion discussion topic for the original entry at https://peakprosperity.com/warning-stocks-likely-to-crater-from-here/

Some comment by Jesse about this.

Flow of funds: Where else can investment dollars go?  Bank deposits and CD's - I don't think so.  Medium and/or long-term bonds?  Suicide, unless you believe we are headed to deflation/depression (How likely is it that the Fed will not do everything in its power to prevent this as it is doing now?).  If the Fed cannot reverse any future downward deflationary spiral, it's 'game over.'  The Fed and our elected dolts in congress will continue the party until they can't - and probably a lot longer than you or I care to admit.  What was that old saw about the market being able to continue in a confounding and contrary direction longer than your liquidity?  Push comes to shove, our government (however you define that, TPTB, etc) will use America's two aces up the sleve: (1) our vast natural resources - the carrot, and (2) our unsurpassed military strength - the stick.  Just pray that a Black Swan doesn't show up on our doorstep.   

It's amazing the markets have held strong this long.  I'm curious to hear from more financially savvy readers what this type of correction would mean for the "real economy" in terms of jobs and income opportunities for most americans.  Also, what happens once a bottom has been reached?  Do we then reverse trend and move full steam ahead to the fourth peak, or are the pumps that drove this most recent "recovery" out of juice?  Where do we go from here and what happens to those of us who didn't have enough time to shake off student debt and buy farm land?

I like Jessie, But he spends too much time and energy on thinking that China will be a catalyst to crisis.  It won't happen.  China can do what they want, when they want, with very little repercussions.  They've increased their reserves in most commodities, unlike the Western Countries.  All of this along with Foriegn Reserves sitting in the bank.  China will not be an issue…unless they choose to be.  
Now, if China decides to sink the West, that would be the only catalyst that I could see from them that would cause such havoc.

Funds don't go anywhere, but the bank, pocket or matress.

I'm after a bit of advice on this if I may - I have an inherited fund which is in a managed portfolio with about 70% in equity. What should I do? If I take it all out I have to pay a bunch of capatal gains tax on it… Or leave it in and have the broker buy some bonds? Of course the broker is telling me to calm down and take the rough with the smooth and look long - yeah right. Any advice appreciated.

Personally, and I'm not a professional, I would move it into the Central Fund of Canada (CEF).http://www.centralfund.com

Can you just go to cash?I personally DO NOT listen to a Stock Broker, who isn't a Stock Broker as I define them to be but are in fact a salesman. Trust your gut. These Stock Brokers get Golf Balls to push a certain Mutual Fund onto the clients, and do the company spiel of Buy and Hold, while the company shorts or longs the market.
Note: I DO NOT favor other people handling my money, and is why I torcher myself every day doing this, which I truly love.

Where is there blood now?  Where is the puck headed?  Certainly not bonds, though a market dump could bring about some short term gains.  Some blood out there in the PM metal funds like CEF (mentioned above), PSLV, and PHYS.   
The most blood is in the miners of metals, and the drillers of oil;

SDT, rights to the oil stream from US-based horizontal drilling;  current yield is 17.8 %


GORO,  Gold miner, P/E = 11.2, yield = 5.5 %


IAG, Gold miner, P/E = 8, yield = 3.7 %


The real question is, What will Bernanke do when the market drops 20%? The answer is charge banks for holding excess reserves. This was in Ben's famous deflation speech. What will happen to markets when he does that-rally, big time to new highs and then some.

Copper, Oil, Gold, and Silver = Rising Dollar?. First in and first out of a Recession?


The real question is, What will Bernanke do when the market drops 20%? The answer is charge banks for holding excess reserves. This was in Ben's famous deflation speech. What will happen to markets when he does that-rally, big time to new highs and then some.
Someone is already mulling that idea and may put it to the test before the US.

Bank of England mulls negative interest rates Paul Tucker, deputy governor for financial stability, raised the possibility in front of MPs after saying the Bank could be doing more to help the economy, including measures to boost lending to small businesses. Negative interest rates would mean high street lenders paying the central bank to place their money with it. The move would be intended to encourage more lending to businesses and households. But it could also lead to a reduction in the interest paid on individual savers’ accounts held with high street banks. The Bank has considered cutting rates from their record low of 0.5pc in the past but decided against doing so for fear of bankrupting a number of smaller building societies. To get round the problem, the Bank is reviewing a possible change to its remit so it can set a separate interest rate specifically for excess deposits placed by financial institutions at the central bank. Addressing the Treasury Select Committee, Mr Tucker said: “I hope that we will think about the constraints of setting negative interest rates. This would be an extraordinary thing to do and it needs to be thought through carefully.”
To the extent that we have positive inflation, a vast blob of Treasury paper is already yielding negative interest rates and still banks buy and hold them.  In order for the applied negative interest rates to be effective, the rate of (negative) interest has to be sufficient to overcome the lack of desire to lend. I'm not sure what that rate would be, but I'll bet that it's a lot more than the Fed would be willing to entertain right out of the gate.

Why do you think Bernanke would show any hesitatation in the face of a precipitous decline? He got burned reacting slowly once. Why would he risk it again?

I look at this whole situation and wonder how they can ever get out of the created mess.
Can't cut out of it

Can't manage out of it

Can't grow out of it.

Literally in what is known in the aviation world as a coffin corner.

I read five things:

  • technical indicators look problematic
  • chart patterns (triple top possibility) cause for concern
  • valuation isn't "cheap"
  • summertime isn't the best time to own stocks
  • macro issues about energy, taxes, etc, are of concern
I agree with everything.  But to go to the next step and say this will cause a 50% drop in stock prices seems...extraordinary.  In 2008, we had a decade-long property bubble pop and trillions in threatened deflation from loans going bad - by surprise - to cause the market to drop 50%.  Bear went down, Lehman went down, AIG went down, Freddie & Fannie went down.  All the major banks were dead men walking.  Literally, the realization that TRILLIONS in loans were all going to go bad hit over the space of about six months.

This time, what waits in the offing to cause that same level of financial catastrophe?

To me, for this big of a move to occur, there has to be some ponzi/bubble element that is revealed in some section of the economy.  For instance, it could be Credit Default Swaps at the major banks, or a sovereign default in some nation that our banks have lent a bunch of money to.  Breakup of the eurozone, popping of the credit bubble in Japan, a problem with "the Bomb", or a major rise in US interest rates.  These are my concerns, and if any of these events come to pass might well lead to major equity market corrections.

But all I get out of the current list together with the current timing is the potential for a 10-20% correction.  The US Government continues to borrow and spend a trillion a year to keep the economy afloat.  As long as that goes on, and there is no major upheaval in the world, why would this particular correction lead to the apocalypse?

I do think a trend change might be coming.  Getting long now is not buying cheap.  But unless a Black Swan hits, I don't see that conditions have changed enough for anything more dramatic than a 10-20% move.

I also believe we got to SPX 1500 by increasing corporate profits rather than through a shadowy manipulation scheme.  If you look at the big four economic data series: Industrial Production, NonFarm Payrolls, Real Personal Income, and Real Sales, they've all been climbing steadily during the past 3 years.  This causes the major equity market indicies to climb steadily right along with them.  The manipulation that is happening is very straight forward - the Fed is keeping rates absurdly low through all its bond-buying, the Treasury is injecting a trillion dollars more than it collects each year into the economy, there are a lot of people out of work, and these things helps business lower cost of debt, keep employee wages low, keeps the dollar relatively low, keeps demand afloat, and profits stay high.  That drives the market higher.  Simplest explanation is most likely correct - Occam's Razor and all that.

Oh none of it is sustainable long term, it will end in tears, and so on.  But I don't think the meltdown will happen in the US until some other places in the world blow up first.  The core dies last - and I strongly believe, the US remains the core economy.

Here's a link containing 3 of the most critical economic time series alongside a chart of the DJIA.  You can see how nicely they all flow together - picture is worth 1000 words, etc.


So my opinion is: correction - odds are increasing.  Apocalpyse?  Not until a bubble-pop type of black swan hits of the magnitude of the one in 2008.

Since we can't know what the market will do, I attempt to stay in the stock market during an uptrend and begin selling when in a correction.
On March 16, 2011, Chris Martenson gave the following: "Alert: Nuclear (and Economic) Meltdown in Progress."  He called it "the highest level alert to my readers than [sic] I have to date".  The market has been up 14% since then.

Instead of trying to guess what's going to happen next, or predict a doomsday scenario (often based on a world view instead of evidence), it makes more sense to be in the market during an uptrend, start selling when it's under pressure and to start getting out when it's in a correction.

People have been predicting an apocolypse forever.  I doubt it but, even a broken clock is right twice a day.

I enjoy the many different views presented here. The indivudual I "trust most" is Jeremy Grantham. From his February letter:
Investment Implications
Courtesy of the above Fed policy, all global assets are once again becoming overpriced. This reminds me of the idea sometimes attributed to Einstein that a workable definition of madness is constantly repeating the same actions but expecting a different outcome! But, as always, asset prices are not uniformly overpriced: emerging markets and, we believe, Japan are only moderately overpriced. European stocks are also only a little expensive, but in today’s world are substantially more risky than normal. The great global franchise companies also seem only moderately overpriced. Forestry and farmland, which is not super-prime Midwestern, is also only moderately overpriced but comes with our nook and cranny sticker attached. But much of everything else is once again brutally overpriced. Notably, U.S. stocks (ex “quality”) now sell at a negative seven-year imputed return on our numbers and most global growth stocks are close to zero expected return. As for fixed income – fugetaboutit!  Most of it has negative estimated returns on our data, and longer debt, as always, carries that risk that may be slight in any period, but is horrific if it occurs – accelerating inflation.

agreed, Grantham is well respected by me too.

I totally agree about staying with the trend.  I also can't agree more about not knowing what the market will do.As a result, I think it is important to have strict criteria - a clear, and well-defined point at which you will bail out, one that you determine prior to the correction happening, so you can take emotion (hope, fear, greed) out of the execution of your trade.  Otherwise, you run the risk of riding the correction down in the hope (emotion) that it really isn't a correction at all.  And if Chris is right and this turns into something more dramatic, the loss would turn from unfortunate to catastrophic.  After all, not knowing what the market will do must include the chance that Chris is right about the outcome and the timing.
Many - if not most - people do not have this discipline, and they hold on and hold on (hope) and end up selling right at the bottom (fear), when all hope is gone and it looks like the world is going to descend into depths from which it will never recover.
I also agree that its unwise to make trades based on macro observation, but rather from how the market itself is reacting to events.  For example, if it rises on bad news - that's positive.  If it sinks on good news, then that's negative.  High volume down days are not good - and low volume up days following the high volume down days - taken together are a sign of a top.
This stuff isn't easy, or we'd all be rich and retired.