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.