Last week’s volatility to the downside was entirely
predictable, as the first leg down during this ongoing market crash
reached the correction stage of 11%. The technical bounce was a given,
as the 30 year old HFT MBAs on Wall Street have been trained like rats
to BTFD. In their lemming like minds, it has worked for the last six
years of this Federal Reserve created “bull market”, so why wouldn’t it
work now. Last week was their first lesson in why it doesn’t work during
bear markets, and we’ve entered a bear market. John Hussman seems
amused at the shallowness of the arguments by Wall Street shills and
CNBC cheerleaders about the future of the stock market in his weekly
letter. After this modest pullback from all-time highs, the S&P 500
is still overvalued by 92%:
Following the
market decline of recent weeks, the most reliable valuation measures we
identify now project average annual nominal returns for the S&P 500
of about 0.5% in the next 10 years. On a broad range of historically
reliable valuation measures (see Ockham’s Razor and the Market Cycle)
the May peak in the S&P 500 reached valuations averaging about 114%
above run-of-the-mill historical norms – more than double the valuation
levels that have historically been associated with the 10% average
expected market returns that investors have enjoyed over the long-term.
At present, those measures have retreated to about 92% above historical
norms.
Keep in mind that
low interest rates don’t raise the estimated 10-year expected return on
stocks from the current 0.5% level. Low interest rates only make the low
expected return on stocks somewhat more “acceptable” because the
alternatives are similarly dismal. The Federal Reserve’s policies of
zero interest rates and quantitative easing have done nothing but to
encourage yield-seeking speculation, bringing valuations to extreme
levels, and leaving prospective future investment returns equally
depressed.
Those who assert
that high equity valuations are “justified” by low interest rates are
actually (and probably unknowingly) saying that 0.5% expected returns on
equities over the coming decade are a-okay with them. But it’s
critically important to understand that while low interest may help to
explain why current market valuations have been driven to obscene
levels, low rates do not change the relationship – the correspondence –
between elevated valuation levels and dismal subsequent long-term market
returns.
It is time to assume crash positions because we
have not experienced anything approaching a crash thus far. We’ve hit
nothing but an air pocket. As Dr. Hussman points out so succinctly,
market crashes do not happen at the peak. There is usually an initial
10% to 14% decline as the smart money exits stage left, then the lemming
dip buyers pile in and drive the market back up, but fail in bringing
it above the initial high. It’s only then that sentiment deteriorates,
support levels are broken, and all hell breaks loose. That time is
coming.
The market decline
of recent weeks was not a crash. It was merely an air-pocket. It was
probably just a start. Such air pockets are typical when overvalued,
overbought, overbullish conditions are joined by deterioration in market
internals, as we’ve observed in recent months. They are the downside of
the “unpleasant skew” that typically results from that combination – a
series of small but persistent marginal new highs, followed by an abrupt
vertical decline that erases weeks or months of gains within a handful
of sessions (see Air Pockets, Free-Falls, and Crashes).
Actual market
crashes involve a much larger and concerted shift toward investor
risk-aversion, which doesn’t really happen right off of a market peak.
Historically, market crashes don’t even start until the market has first
retreated by 10-14%, and then recovers about half of that loss,
offering investors hope that things have stabilized (look for example at
the 1929 and 1987 instances). The extensive vertical losses that
characterize a crash follow only after the market breaks that apparent
“support,” leading to a relentless free-fall that inflicts several times
the loss that we’ve seen in recent weeks.
It’s hysterical watching the paid Wall Street
hucksters paraded on CNBC and the other corporate media propaganda
outlets trying to calm the muppets so they can continue to fleece them.
The highly paid talking heads, bubble headed bimbo spokesmodels, and
captured shill “experts” like Cramer, blather about the 10% decline as
if it has been an extreme over-reaction to a meaningless possible .25%
increase in an obscure Fed lever and the complete collapse of the China
bubble economy. They knowingly ignore the extreme valuations of our
stock market to levels only seen in 1929 and 2000. Their goal is to keep
the muppets in the market so their advertising revenue stream from Wall
Street continues unabated.
The reason why the
word “crash” has been bandied about to describe the recent selloff, I
think, is partly because investors have lost all perspective of the
losses that have historically been associated with that word, but mostly
because it gives market cheerleaders the needed “cover” to encourage
investors to continue speculating near record market valuations. After
all, everyone “knows” that investors shouldn’t sell after a crash, thus
the endless flurry of articles advising “selling in a crash is a textbook mistake,” “selling off stocks during a crash is a terrible idea”, “whatever you do, don’t sell”, “market crash: don’t rush to press the panic button,” “the worst investing move during a market crash,” … you get the idea.
Hand-in-hand with
the exaggeration of the recent decline as a “crash” and “panic” is the
exaggeration of investor sentiment as being wildly bearish. The actual
shift has been from outright bulls to the “correction” camp, but that’s a
rather meaningless shift since anyone but the most ardent bull would
characterize current conditions as being at least a market correction.
Historically, durable intermediate and cyclical lows are characterized
by a significant increase in the number of outright bears. That’s not
yet apparent here. Indeed, Investors Intelligence still reports the percentage of bearish investment advisors at just 26.8%.
The reason people lose so much money during market
crashes is because of their cognitive dissonance and normalcy bias. They
don’t want to think about the possibility of losing 50% of their money,
even though history, facts, and common sense all point towards a
dramatic crash. They will be convinced to stay in the market by the
dramatic rallies that occur during bear market crashes. Six of the
largest one day gains in history occurred during the 2008/2009 crash.
Did that result in people not losing 55% of their money over a few month
period? Selling now would not be a panic move, it would be a rational
move.
It’s generally true
that one doesn’t want to sell stocks into a crash (as I’ve often
observed, once an extremely overvalued market begins to deteriorate
internally, the best time to panic is before everyone else does). Still,
the recent decline doesn’t nearly qualify as a crash. For the record,
those familiar with market history also know that even “don’t sell
stocks into a crash ” isn’t universally true. Recall, as an extreme
example, that from September 3 to November 13, 1929, the Dow Industrials
plunged by -47.9%. The market briefly recovered about half of that loss
by early 1930. Even so, it turned out that investors would ultimately
wish they had sold at the low of the 1929 crash. By July 8, 1932, the
Dow had dropped an additional -79.3% from the November 1929 trough. In
any event, the recent market retreat, at its lowest closing point, took
the S&P 500 only -12.2% from its high, and at present, the index is
down just -9.7% from its highest closing level in history. To call the
recent market retreat a “crash” is an offense to informed discussion of
the financial markets.
The biggest fallacy bought into by the ignorant
masses and the intellectual academic elites is that the Federal
Reserve’s purposeful blowing of this enormous bubble has increased the
wealth of the nation. It has done nothing of the sort. It has increased
the debt of the nation, while starving the productive wealth creating
segments of the nation. They have created paper wealth by encouraging
reckless gambling by Wall Street and the corporations using shareholder
funds to buy back their stock at all-time highs. As we saw in 2000 and
2007, paper wealth can vaporize overnight.
Keep in mind that
when paper wealth is “lost,” nobody gets it. Quantitative easing has not
made the nation “wealthier”, nor will the massive paper loss we expect
over the completion of the market cycle make the nation “poorer.” As I
detailed in June (see When Paper Wealth Vanishes):
“As in equal or
lesser speculative bubbles across history, there’s a common delusion
that elevated stock prices represent wealth to their holders. That is a
fallacy, and we can hardly believe that given the collapses that
followed the 2000 and 2007 extremes, investors (and even Fed
policymakers) would again fall for that fallacy so readily. The actual
wealth is in the cash flows that are ultimately delivered into the hands
of shareholders over time. Individuals can realize their paper wealth
by selling now to some other investor and receiving cash in return, but
only a small proportion of investors can actually convert current paper
wealth into cash by selling to other investors without disrupting the
bubble. The new buyer then receives whatever cash flows the stock
delivers into the hands of existing holders, and can eventually sell the
claim to the remaining stream of future cash flows to yet another
investor. Ultimately, a share of stock is nothing but a claim on the
long-term stream of cash flows that will be delivered into the hands of
its holders over time. The current price and the future cash flows are
linked together by a rate of return: the higher the price you pay today
for a given stream of future cash flows, the lower the rate of return
you can expect achieve by holding that investment over the long-term.”
The Federal Reserve has been successful in
redistributing the wealth of the nation to the .1% who control the
levers of our economic, financial, and political systems, from the
working middle class who do the heavy lifting in this country.
Redistributing wealth through speculation, rigging markets, printing
money and throwing savers and senior citizens under the bus is not
creating wealth. The biggest debt bubble in world history will lead to
the greatest financial collapse in world history. Act rationally and get
your money out of the stock market now.
Emphatically, the
wealth of a nation is not measured by the price that the most reckless
speculator will pay for the last few shares that change hands at the
most exuberant moment of a bull market, multiplied by the entire number
of shares outstanding. No, the wealth of a nation is its accumulated
stock of productive real investment, human capital, and resources.
Everything else cancels out because every security owned by some holder
is also the liability of some issuer (see Stock Flow Accounting and the Coming $10 Trillion Paper Loss).
Put simply,
many investors, and even some policy makers at the Federal Reserve, are
under the delusion that paper market capitalization represents real
wealth to the economy as a whole. The truth is that the wealth is in the
productive assets of the economy and the long-term stream of cash flows
they generate. Price fluctuations can certainly affect the distribution
of wealth. Those who repeatedly buy stocks from others at depressed
prices, and sell them to others at elevated prices, will accumulate the
purchasing power of others. Those who repeatedly do the opposite will
surrender their purchasing power to others. But the aggregate wealth of
the economy as a whole is unaffected by those price fluctuations.
