Where is that old-and-tattered “Crash Alert” flag?
Many times since the start of the rally in U.S. stocks in 2009, we hoisted it. And many times has it failed to give us a useful signal.
But we will bring it out again, if a bit sheepishly… and let it wave, in the warm Argentine air.
Why? Do we know a crash is coming?
No, of course not.
Is our flag a good indicator of what will happen?
But we regard it like the “Shark Alert” flags you see on the beaches of Australia. (Down Under is the only country in the world to have a chief of state who was eaten by a shark.)
The “Shark Alert” flag doesn’t mean you can’t go swimming. It means if a shark takes a bite out of you, it’s your own damned fault.
Why are we raising the flag again now? Economist and fund manager John Hussman, of Hussman Funds, explains:
Last week, the CAPE ratio of the S&P 500 Index surpassed 27, versus a historical norm of just 15 prior to the late-1990s market bubble. [The CAPE ratio – also known as the Shiller P/E ratio – looks at inflation-adjusted earnings over a 10-year period to control for cyclicality in earnings.]
The S&P 500 price-revenue ratio surpassed 1.8, versus a pre-bubble norm of just 0.8.
On a wide range of historically reliable measures (having a nearly 90% correlation with actual subsequent S&P 500 total returns), we estimate current valuations to be fully 118% above levels associated with historically normal subsequent returns in stocks.
Advisory bullishness (Investors Intelligence) shot to 59.5%, compared with only 14.1% bears – one of the most lopsided sentiment extremes on record.
The S&P 500 registered a record high after an advancing half-cycle since 2009 that is historically long-in-the-tooth and already exceeds the valuation peaks set at every cyclical extreme in history but 2000 on the S&P 500 (across all stocks, current median price-earnings, price-revenue and enterprise value-EBITDA multiples already exceed the 2000 extreme).
The water is full of sharks, in other words. And that’s why this is the best time to get out of the market in the next eight years, says Hussman.
Over that time, he says, the likely return from a balanced portfolio of stocks and bonds is zero.
So nutty are U.S. stock market valuations (in light of the economic situation) that SocGen equity strategist Albert Edwards is afraid he may be going bonkers, too:
We are at that stage in the cycle where I begin to doubt my own sanity. I’ve been here before though and know full well how this story ends and it doesn’t involve me being detained in a mental health establishment (usually).
The downturn in U.S. profits is accelerating. And it is not just an energy or U.S. dollar phenomenon – a broad swathe of U.S. economic data has disappointed in February.
One of the positive surprises, payrolls, is a lagging indicator. The $64,000 question is not if, but rather when, will investors realize what is going on?”
Why the Rich Get Richer…
Lately, we have been thinking about how we – and almost everyone else – misjudged the potential inflationary effects of central bank policies (ZIRP and QE).
As we mentioned yesterday, central banks are not really “printing money.” Nor are they really stimulating the economy.
Instead, they are putting credit on sale. Yesterday, Chris provided some detail on how U.S. corporations are using this cheap credit to buy back their own shares.
February set a new record for share buybacks. U.S. corporations spent a staggering $5 billion a day on their own shares. That brings the tally to $2 trillion since the bottom in U.S. stocks in 2009 – or about 10% of the total value of the S&P 500.
This is the effect of cheap credit: It gooses up asset prices. It encourages speculation and quick-buck gambling.
It does not raise consumer prices or help the real economy.
Instead, the rich get richer – because assets go up in price. And the poor get poorer – because real investment, the kind that produces jobs and incomes, goes down.
Curiously, even former Fed chairman Alan Greenspan, now at liberty to speak the truth, said so.
“The single biggest problem in our economy,” according to Greenspan, “is a lack of real capital investment.”
Cash Will Be King
Instead of the kind of patient, sensible, capital investment that we would see in a genuine boom, the Fed’s EZ money policies encourage bubbles. Hussman:
When investor preferences are risk seeking, overly loose monetary policy can have a disastrous effect by promoting reckless speculation and enhancing the ability of low-quality borrowers to issue debt to yield-starved investors.
This encourages malinvestment and financial distortions that then collapse, as we saw following the tech and housing bubbles. Those seeds have now been sown for the third time in 15 years.
All bubbles burst. They burst whether the Fed is raising rates or lowering them. And all bubbles burst in a way that destroys credit but raises up the value of cash.
This is the curious phenomenon that almost nobody but us sees coming…
The Fed pumps up the monetary base – made up of commercial banks’ reserve accounts at the Fed plus physical currency circulating in the economy – to about $4 trillion. But instead of a falling dollar, the greenback becomes so valuable that people cannot live without it.
Cash will be king. Emperor. Rock star. And Oscar winner.
Stay tuned… we’re getting somewhere important…
Further Reading: Bill’s “Crash Alert” flag may be old and tattered… But his colleague Braden Copeland is out with brand-new research on why the next crash in stocks could be much worse than in 2008. In fact, he’s urging all readers to protect their profits immediately. To see why he’s so worried, click here now…