Are We on the Verge of a Market Crash?

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.
[two bears]

Much like the Great Depression did to the “Greatest Generation,” the financial crisis of 2008 seared the souls of millions of investors. Almost six years after the collapse of Lehman Brothers, professional Cassandras never ceased predicting that the next economic meltdown and a stock market crash is just around the corner.

That’s ironic…

After all, U.S. stock markets have been in a classic bull market for over five years now.

Instead of gold hitting $5,000 an ounce and the Dow Jones collapsing below 1,000, the S&P 500 has risen 189% from a low of 683 on March 2, 2009, to yesterday’s close of 1,971. The Nasdaq closed yesterday at its highest level since early 2000.

And that’s with the most anti-business U.S. administration since the days of Woodrow Wilson.

The Case Against a Coming Crash

First, let’s review the factors that have supported this surprising bull market.

Most of the global economy has recovered from the very worst of the economic contraction between October 2008 and March 2009. Strong earnings growth, combined with record levels of share buybacks, has boosted companies’ earnings per share. Finally, artificially low interest rates supplying liquidity to the banking sector have served as a tailwind to asset prices around the world.

There are still several contrarians willing to endure the public humiliation of being in the bull camp. The much-reviled Goldman Sachs reckons that another economic collapse is unlikely. Sure, Goldman concedes that the stock market could crash any day. But one of the key preconditions needed for an economic bust is high credit growth. Credit may be accelerating. But in the grand scheme of things, it’s still at pretty low levels. The global economy is more macro-economically stable than headlines would suggest.

Exclusive  Georgia Runoff Matters Little to Year-End Rally

Steven Auth of Federated Investors is another brave bull who thinks the S&P 500 will hit 2,100 by the end of 2014. Auth also predicts the S&P 500 will reach 2,500 within the next 18 months to two years. The combination of growth, bond rates and perceptions of risk will continue to propel the U.S. stock market ahead. With the Fed paranoid about tightening rates too soon, as it did in 1937, a liquidity backdrop for stocks will remain favorable.

The Case for a Coming Crash

Yale University Professor — and now Nobel Laureate — Robert J. Shiller is a famous stock market bear. He is one of the brains behind the Cyclically Adjusted Price Earnings (CAPE) ratio — a smoothed 10-year average price-to-earnings ratio.

In Schiller’s view, the U.S. stock market is very expensive. Today, the U.S. stock market’s CAPE is hovering at a worrisome level of above 25. It’s only been higher three times in the last 135 years: in 1929, 1999 and 2007. Each of those years was followed by a major market crash.

Shiller’s analysis makes it seem like a bet against the U.S. stock market is a no brainer.

It is… until you learn that based on Shiller’s CAPE measure, the U.S. market has been overvalued for the past 20 years.

Since August 1994, the S&P 500 has risen from 463 to 1,971 yesterday. Had you listened to Shiller, you’d have missed out on a 4.25X rise in U.S. stocks.

The Answer Is… “I Don’t Know… and Neither Do You”

Opinions on the outlook for the market are a dime a dozen. If we throw enough darts at the board of market prediction, someone is bound to hit a bull’s eye. Nothing is more common on Wall Street than this year’s “one hit wonder” in market prognostication.

Exclusive  Giving Thanks and Naming Names

But the way humans are wired, even if we aren’t right about our predictions, our ability to rationalize is boundless.

Here’s a personal example…

A few years ago, I predicted that the Dow would reach 15,014 by October 2012. This was based on the average return of the Dow following lows hit on a measure of consumer confidence. I was widely mocked at the time for the temerity of such an absurd prediction.

Well, sure enough, when October of 2102 rolled around, the Dow had yet to hit that level.

But six months later, the Dow did breach 15,000. And yesterday it closed at of 16,838.

Objectively, the Dow failed to hit my target by the date I set out.

But, in my mind, I wasn’t “wrong.”

I was just early.

After all, I was a lot more right than Robert Prechter, who predicted the Dow would crash to 1,000 around the same time.

That reminds me of joke.

Question: “Why is rationalization more important than sex?”

Answer: ”Try going a week without rationalization.”

The only real answer to whether the market crash is coming is “I don’t know.”

But smart people have a tough time uttering those simple words.

Here’s how Robert Shiller said “I don’t know” in a recent article:

…nothing I’ve come up with is a slam-dunk explanation for the continuing high level of valuations. I suspect that the real answers lie largely in the realm of sociology and social psychology — in phenomena like irrational exuberance, which, eventually, has always faded before. If the mood changes again, stock market investments may disappoint us.

Sadly, measured answers like that don’t fit into 140 characters on Twitter.

Exclusive  Republicans Trump Democrats, Stocks Soar

And I bet Shiller would sell a lot more books with: “Gold will hit $10,000 by Nov. 1; on the brink of World War III!”

After all, investors prefer a punchy wrong answer to a wishy-washy correct one.

Robert Hall, my Stanford macroeconomics professor and now chair of the Committee on Business Cycle Dating — the folks who officially call recessions — provided a more pithy answer than Shiller in this week’s Economist:

“The next recession will come out of the blue, just like all its predecessors.”

I believe you can say the same thing about the next stock market correction.

In case you missed it, I encourage you to read my e-letter column from last week about the Arab economies you should invest in. I also invite you to comment in the space provided below.

Like This Article?
Now Get Our FREE Special Report:
Alternative Investing: Investing in Timber

Stock Investor editor Paul Dykewicz reveals why investing in timber may be one of the best long-term portfolio strategies you'll find today.

Get Access to the Report, 100% FREE


img
previous article

As I expected, U.S. markets bounced strongly last week. The Dow Jones rose 0.66%, the S&P 500 recovered 1.22% and the NASDAQ jumped 2.15%. The MCSI Emerging Markets Index joined the recovery party, rising 1.83%. Last week’s Bull Market Alert bet on a bounce in the Dow Jones, ProShares UltraPro Dow30 (UDOW), ended up a solid 2.48% in its first week in your portfolio. And if it weren’t for Friday’s scare on news surrounding the fighting between Ukraine and Russia, the wee

PREMIUM SERVICES FOR INVESTORS

Dr. Mark Skousen

Named one of the "Top 20 Living Economists," Dr. Skousen is a professional economist, investment expert, university professor, and author of more than 25 books.

Product Details

LEARN MORE HERE

Bryan Perry

A former Wall Street financial advisor with three decades' experience, Bryan Perry focuses his efforts on high-yield income investing and quick-hitting options plays.

Product Details

LEARN MORE HERE

Jim Woods

Jim Woods has over 20 years of experience in the markets from working as a stockbroker,
financial journalist, and money manager. As well as a book author and regular contributor to
numerous investment websites, Jim is the editor of:

Product Details

LEARN MORE HERE

Bob Carlson

Bob Carlson provides independent, objective research covering all the financial issues of retirement and retirement planning. In addition, Bob serves as Chairman of the Board of Trustees of the Fairfax County (VA) Employees’ Retirement System, which has over $2.8 billion in assets.

Product Details

LEARN MORE HERE

Hilary Kramer

Hilary Kramer is an investment analyst and portfolio manager with 30 years of experience on Wall Street. Since 2010, Hilary's financial publications have provided stock analysis and investment advice to her subscribers:

Product Details

LEARN MORE HERE

Jon Johnson

Jon Johnson's philosophy in investing and trading is to take what the market gives you regardless if that is to the upside or downside. For the past 21 years, Jon has helped thousands of clients gain success in the financial markets through his newsletters and education services:

Product Details

LEARN MORE HERE

DividendInvestor.com

Used by financial advisors and individual investors all over the world, DividendInvestor.com is the premier provider and one-stop shop for dividend information and research.

Product Details

Popular tools include our proprietary Dividend Calendar, Dividend Calculator, Dividend Score Card, and many more.

LEARN MORE HERE