The coming stock market crash of 2017-2018

Topic: The case for a 50% downside for stocks in the coming 12 months, and then some

Style: Funny, ’cause it’s true (kind of)

Nota bene: this post should be read in conjunction with my previous post on the bull case for stocks


1 The trend has gone too far

I mean, what are the odds of this trend continuing (see chart) without a major hickup?

Trees don’t grow to the sky. Sooner or later, the human psyche will pull the index back to its long term trend (asymptotic to population growth + productivity growth)

Remember that stocks went nowhere between 1996 and 2009, and 2000 and 2012 or was it 2013? That’s a long time going nowhere and it seems to be about time for a re-run of a crash and no returns fro a dozen year or so.

2 Stocks are expensive

Historical peaks in the S&P 500 ratio have only briefly broken above the 20 level. Today we’re at 24.57. And that’s with significant accounting tricks, massive stimulus, zero interest rates and a generally upbeat mood and risk tolerance at highs. Whenever stimulus wanes, reality comes back to bite creative accountants in the derriere, interest rates stop falling or start rising P/E-ratios are bound to explore earlier depths. And that’s even before taking into account a less optimistic sentiment, as well as increasing actual need for funds.

By the way, here is an alternative valuation measure. It’s based on Price/Sales (from Hussman Weekly the previous week) which is an automatically cyclically adjusted valuation measure (more or less) Notice how the valuation measure has increased 4-fold since 2009. That alone carries an inherent risk of a ca. 75% fall in share prices, if sentiment were to fall to 2009 levels.

A permanently higher plateau?

3 Profits are going… where exactly?

Not that fundamentals are that important, except over very long time periods, but the profits have stalled lately. That’s despite historically hysterical monetary stimulus and budget deficits (essentially fiscal stimulus one way or the other). It’s hard to conceive of a new and bigger wave of stimulus on top of the already failing ones. There is no new China, no new India, no hoping for Africa to pull profits higher when the low hanging fruit in the U.S. and Europe have been plucked.

In addition, after 9 years of expansion a profit recession is way overdue. The profits for S&P companies quite often decrease by 30-50%, and the swings have become bigger since 1980, not smaller.

With both lower earnings multiples and stalling or falling earnings in the cards, a 50% decrease in S&P 500 is actually a quite modest expectation. Time for a black Friday soon?

Labor costs recently hit a low (inverted scale) and profit margins a mirroring high. With the magic of debt (that postpones the need for a real living wage) faltering it’s about time wages reflected living costs, and margins came back to earth. Guess what’ll happen to profits… Hint: it’s not positive.

4 Interest rates are about to rise

This chart speaks for itself, I hope. With interest rates this low, the only way is up. Retirees and pension funds can’t live off of a 2.2% return. Nominal!

Look at the chart, can you honestly say you think rates are going even lower? Anyway, rates don’t really matter, at least not fundamentally. If rates are staying low or going lower, then history teaches us that it’s because growth is low. In terms of equity valuations, lower interest rates and lower growth will cancel each other out. No, matter, unless we go completely digital, interest rates are not going negative (for long). A situation where suppliers want to be paid late, where you’re paid to mortgage your house and so on, simply is to perverse for an economy to take.

5. Dividend yields are low, and if they are about to rise, it’s only because stock prices are about to come crashing down

The dividend yield is lower than the interest rate, but rates are fixed and nominal, whereas dividends are risky and contingent of profits and not least cash flow. Dividends can be reduced or cancelled altogether.


Many more and bigger fundamental reasons to worry

There are of course numerous more reasons to expect lower profits, multiples and share prices, such as profit margins mean reverting (or inverting!), increasing churn rate among the top companies in a digital world etc. No need to mention the boomer cohort retiring, thus both reducing their equity portfolios, and cutting back on consumption (due to uncertainty about longevity and investment returns; feeding into lower sales and profits on top of any other adversity or recession trigger). I also don’t want to spoil any bull party with mentions of the debt ceiling and a congress that actually wants to see the president fail.

Finally, there is that minor detail of all too much debt in all sectors of the economy (government, corporate, student, auto, mortgage, credit cards) having already pulled sentiment and consumption forward, and henceforth putting a lid on future growth.

Oh, I almost forgot The Fourth Turning which with impeccable timing is soon upon us with its convenient total solution to small matters such as a failing European Union, currency wars, nuclear bickering with North Korea, unsustainable pension promises and the obese healthcare sector. Maybe a digital World War III, followed by a gold backed cryptocurrency fiat re-set accord could interest you?


And the bad news?

Technicals don’t look good either. Dr Hussman has frequently noted that high valuations alone rarely slow down equities. However, when the appetite for risk eventually recedes, it’s visible in “market internals”.

He theorizes that when risk is in universal demand it makes asset classes, industries, sectors and companies converge. The mirror image of such bull behavior is widening dispersion in a number of respects as a harbinger of more widespread flight to safety. The FANG phenomenon is hardly new, and narrowing markets are but one example of an early risk off signal for equity markets.

FYI: As of August 14, Dr Hussman no longer calls the rising risk aversion subtle.

Ain’t nuthin’ but a FANG!

As a final word: never forget that all securities have to be held until retired. That means that no matter how far a stock price has fallen there is still 100% owners, and thus potential sellers of the stock left. If falling equities means record high NYSE margin debt will trigger forced selling those potential sellers risk becoming increasingly urgent. And then there is the case of Ponzi schemes which have an uncanny knack of being exposed and exacerbating the negativity right when they do the most harm.

Do you still preach dancing while the music is playing, albeit close to the exits (or remaining chairs)? I mean, central banks have no way to go but ever more retard. The same goes for banks and corporations. They’ll push for just one more quarter of play pretend. Maybe they can pull themselves up by their own hair a final time before the ultimate solution. Some even claim it was the earlier downturns that were anomalies and due to very specific one-time issues.


Well I’m peepin’ and I’m creepin’ and I’m creep-in

But I damn near got caught ’cause my beeper kept beepin’

Now it’s time for me to make my impression felt

So sit back, relax and strap on your seatbelt


I wouldn’t bet on it; there’s no reason to. You can always decide to simply pass on this round and see what happens. Or, you just have to ask yourself if you feel lucky.

Well, do ya? (Please read this post in conjunction with my previous ironic post on the bull case for stocks)


Are you afraid yet? You should be.

The fire is lit, and there are very few exits — small and obscure ones.

You should be

Gold is one of those exits. Bitcoin might be another. Soft commodities could also be worth a look.


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BONUS: Check out Ludvig’s write-up in English of our interview with billionaire and hedge fund founder Martin Sandquist here.

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12 Comments

  1. It is funny. I love how you use the same charts for both the bull and bear case. One person says internals are worsening. Another person can say he is just a bad stock picker.

  2. I don´t see much that is low priced, washed out, etc in today´s markets except commodities. It´s crazy how so many things are in massive bubbles, except the things that are capital intensive to produce, and limited in supply. Surely if everything is valued at moonbeam levels, commodities should be as well? Oh well, I´m wrong until I am right!

    • I agree on commodities. It’s definitely a conundrum worthy of Greenspan that all inflation is in assets and none in commodities. Not least given the challenges climate change poses for agriculture.

  3. Very interesting. I made a similar analysis back in 2008. At that time, I looked at the historical ratio of the Dow Jones index to nominal U.S. GDP, and I found an interesting thing. This ratio had long term stability for generations; bubbles were sometimes extreme but never lasted long and only in 1930-1934 did the ratio stay significantly below normal. Then in 1987 something interesting happened. There was a dramatic stock bubble, and like every bubble before this one soon collapsed and the Dow Jones returned to its previous ratio. But then it went it right back up, and it kept going up, and it stayed drastically elevated over its stable ratio. It also became /permanently/ unstable, a sure sign of an over-valued market driven by speculation.

    In 2008 I calculated that the Dow Jones need to fall to 5000-6000 to reach its true value, i.e. the point at which the price of stocks corresponds to the actual ability of corporations to pay dividends. I believe the market bottomed at about 7,000, still higher than it should have been – then it went back into an upward spiral.

    My theory is that the cause is a large increase in speculative investment, and that there are two causes for this. One is the popular delusion that stocks are some kind of magical wealth-creating perpetual motion machine. 1929 was finally forgotten and the belief became embedded in our culture that stocks always go up in the long run and are sure to give a better return than anything else.

    The second and perhaps more important cause is that the economy has been fundamentally weak and distorted since at least the Eighties. When the distribution of wealth is too far skewed toward the wealthy, there is a surplus of funds destined for investment (only the rich invest a substantial part of their income). At the same time, declining middle class incomes mean weak consumer demand, making any real (i.e. productive) domestic investment more competitive and riskier. The investor either looks for opportunities overseas, or “invests” the money in purchases of existing things – securities, land, whatever. Since these are mere transactions – the item purchased is in no way improved – they do not contribute to the economy. The money “invested” goes to someone else, probably another speculator who will quickly “invest” it in some other speculation – it may be spent hundreds of times during the year on nothing at all.

    The demand for these objects of speculation thus multiplies enormously. The only thing keeping the Dow Jones from soaring into the millions is that new (often even more worthless) “investments” have been invented to soak up the suckers’ money. Gold is one of these.

    The whole “investment” market is a Ponzi scheme. Purchases are made not for their intrinsic value, but only in the hope that someone will buy them later at an even greater price. This is true of stocks, the price of which is generally fabulous compared to any productive capacity they represent; it is also true of land and of gold, the price of which is grossly out of proportion to their intrinsic value.

    When the U.S. economy collapses, as it must due to the accumulation of debt and the absolute vacuum of leadership, what will be the actual utility of hoarded gold metal? Unlike stocks or perhaps paper money, it will still have /some/ exchange value, but only a small fraction of what it was purchased for when speculation drove an enormous demand for it. And how would an individual American holder prevent its outright confiscation? If the U.S. government stands in some form, it may well claim all gold for itself; if it falls, the police – well armed, organized, and long accustomed to despising mere citizens – will seize everything of value.

    For the rest of the world, the outcome of personal investment choices seems difficult to predict, and perhaps irrelevant. The mainspring of the world’s economy will break soon, and that mainspring is utterly directionless, unprepared for hardship or uncertainty, and heavily armed with nuclear missiles. Y’all got a problem.

    • Great comment (as always when you’re around — I’ve seen your work many times on other sites)

      More debt and more newly printed money leaks into asset prices; real estate, land, stocks, gold. Authorities hope to create inflation, thus raising the level of the rest of the economy until wages and profits are high enough to warrant the high asset prices. They can never catch up of course, since asset prices keep running way ahead of consumer prices and wages. And if they were to succeed, inflation would fed into higher interest rates bankrupting everyone with a debt, including the government.

      What about gold: I’ve written extensively before about how gold is intrinsically worthless (more or less, compared to current prices). That said, gold is still the most solid base for a financial re-set. I’m aware there are plenty of scenarios that render gold worthless (or confiscated), but there are also several paths on which gold appreciates many times over.

      There aren’t many places to hide from the fourth turning, a collapse of old institutions and regimes (such as fiat money, dollar reserve, EU, UN and so on), but gold might be better than others — at least it wont rust, you can dig it down, use it for barter… Land, houses and real businesses and other real assets are also above average places to keep your money.

      All that said, I’m not expecting a total collapse. I’m planning for some 1970s style turmoil, a new currency accord, perhaps high inflation, debt jubilees, a stock market crash etc. In that scenario I’m betting some 5% of my wealth on gold becoming a bargaining chip and a base for the next fiat money regime.

      • Thanks Mikael. I appreciate your optimism but I don’t share it. There are now factors never experienced in previous US Depressions: the U.S. government is already insolvent and lacks any real recourse other than printing money; doing this will make it impossible to borrow at plausible interest rates, forcing the government to print even more money, perhaps even just to pay its operating expenses; most retirement plans and other savings (not just those of intentional speculators) consist mainly of essentially worthless securities; the migration of manufacturing to Asia greatly reduces the potential benefit of any Keynesian program. Perhaps worst of all, a large part of the U.S. debt is held by foreign entities. Printing money to pay the debt will devalue that debt, but it will still involve a large transfer of buying power overseas. China, as both a major creditor and the main supplier of the U.S. market, has a major interest in American policy, and the ability to influence it.

        I suppose your scenario for gold increasing greatly beyond current exchange value is driven by governments competing to stockpile gold to back their currency, a la the 1890’s. In the unlikely event this actually happens, it would still fail to stabilize the monetary system.

        I don’t think we’re facing just another Carter Depression or even another Great Depression, more like a Weimar Republic crisis.

        • Fourth Turning material for sure…

          I reason in a similar fashion, but I fail to fully integrate and assimilate the conclusions out of fear and herd behavior. I just don’t want to be a prepper and build a Bug-Out-Location with canned food, weapons, generators and gas.

          I think we’ll escape the Weimar, Zimbabwe scenario. Maybe Argentina. Maybe US depression, but not Weimar. I think the Singularity comes before :D

    • Regarding gold or other real asset. One rule of thumb is to try to keep it in a different country from the one you live in. In other words, don’t put all the eggs in the same basket.

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