Why Stocks Will Crash – Again
Why Stock Markets Are Headed For A Crash Again
The universal truth about financial markets is that the higher they rise, the harder and faster they fall. Judging from history and using any form of objective measurement one can safely say that the stock market is in a bubble. Just look at the charts, observe the market’s history and you will see the point I am trying to make.
As always, we want to believe that things are different this time, that somehow a magic hand will save us from the path of destroying our wealth. The truth is that our economy is in a much more fragile state than it was before the last recession.
The reality is that our economy cannot take any more damage. It would be one thing if stocks were rising because of the improved condition of the US economy and a completely another fact if it was due to an artificial market bubble.
The current condition of the market is just backed by only one reason, and that is the irrevocable fact that it is in a financial bubble. This bubble will soon burst and take with it all of investor’s wealth.
This recent uptrend in stocks is so similar to the conditions before the 2008 crash. This unexpected rise has all the omens of an upcoming crash.
A useful metric I want to share is the ratio of corporate equities (stocks) to GDP. This ratio is at levels too high and its chart only reached a higher point in 1950. The last time it reached such heights was when the Dotcom bubble burst.
If this graph ever reaches a mean level, it would translate to a 50 percent fall for the stock prices.
Then everyone will be in an uproar. The truth is that it would be a return to reality and normal economic conditions.
Another metric that I consider a good predictor of the stock market is the cyclically adjusted price-to-earnings ratio or CAPE ratio.
While corporate earnings solely depend on the business cycle, their P/E ratios vary widely depending on the path along the business cycle. The CAPE ratio counters the effects of a business cycle by measuring stock prices against the average of inflation-adjusted earnings for ten years. This means that you can fairly judge a company’s profitability irrespective of the prevailing economic conditions.
According to Vanguard, CAPE is one of the best measures for predicting future stock returns.
The CAPE ratio resides at levels that are at their third highest position since 1890. This metric was at its highest peak during 1929 and before the dotcom bubble burst.
The puzzling thing about recent stock market prices is that they still climb higher in spite of the poor revenues the companies register.
Analysts are of the view that the 2015 first quarter revenues for many companies are projected to decline. These will fall at a much more rapid pace, even faster than the last financial crisis.
Estimates show that the revenues of S&P500 companies will decline at least 2.8% in Q1.
NASDAQ is going through the same rampant speculation. Major tech companies that make up the NASDAQ are barely making any profits at all. A bubble that is about to burst.
What’s more interesting is that this elusive love for the stock market is not native to the US. China’s stock market has seen a nearly 80% rise over the past nine months. This comes at a time when the Chinese economy is witnessing the slowest growth in about 20 years. If the Chinese stock market s not a bubble then what else is this?
This is nothing but the calm before the storm. We are at the edge of the fall into the abyss of the next financial crisis.
Employees of these companies know this fact. They laugh at the risk and danger people go through investing in stocks where there is little value.
They know that this cannot go on forever. They know that a financial crisis is lurking in the near future. They know it this will end.
Banks will topple, losses will reign and lives will be destroyed. Yet again, we will see these horrendous risks materialized into the demons of a recession. Those mortgage-backed securities will not save you when there are no banks to guarantee anything but their destruction.
Be prepared, the stock market will crash eventually.