Warnings Grow About the Next Stock Market Crash

By Pam Martens and Russ Martens: July 3, 2018 ~

Broken Piggy BankHere’s the thing about stock market bubbles: they can last far longer than even expert analysis suggests they should. But correctly defining a stock market as an unsustainable bubble is still a worthy exercise since it clarifies how much one stands to lose when the bubble does eventually pop.

One of the market watchers who is unabashedly calling for a major market correction – potentially in the realm of 60 percent from peak to trough – is John P. Hussman, President of Hussman Investment Trust. In his most recent market commentary, Hussman writes:

“Unlike much of the recent bull market, present market conditions reflect not only extreme valuations (including a full syndrome of overvalued, overbought, overbullish features), but also divergence and dispersion in our measures of market internals. It’s that deterioration in market internals that threatens to unleash the beast that has been patiently biding its time within extreme valuations. Given those extreme valuations, I continue to believe that the completion of this market cycle will be a terrible ordeal for passive investors.”

These are among the items that are worrying Hussman:

“Deteriorating participation of individual stocks in the bounce, as more than 40% of individual U.S. stocks are again trading below their respective 200-day averages;

“A leadership reversal on the heels of recent recovery highs, with the number of stocks hitting new 52-week lows suddenly flipping above the number of stocks hitting new 52-week highs…

“Widening credit spreads between the interest rates on low-grade bonds and those of higher-quality bonds, and;

“A sudden break to new lows in Deutsche Bank, the most highly-leveraged major European bank.”

In Hussman’s April market commentary, he warned that the only investors who belong in this stock market are those “whose investment horizons and risk-tolerances could tolerate a market loss on the order of 60% over the next few years (our run-of-the-mill expectation, not a worst-case scenario) and roughly zero returns over the next 10-12 years, without great distress, and without abandoning their discipline. If you’re already experiencing distress at the rather minimal level of volatility and market loss we’ve seen in recent weeks, you’re probably taking more risk than is appropriate.”

At Wall Street On Parade, we synthesize the above as “sell down to your sleep level.”

Hussman’s reference to the number of stocks making new lows versus those making new highs is indeed troubling. But here’s what is even more troubling. It’s been happening on and off for a very long time – longer than historical market norms suggest it should have been going on.

Consider this headline over an article by Tomi Kilgore of MarketWatch: “Stocks Hitting New Lows Outnumber New Highs by Widest Margin in 18 Months.” That headline was written almost a year ago on August 11, 2017. And it notes a repeating trend from 2016. Kilgore writes: “Of all the stocks listed on the New York Stock Exchange, new lows are outnumbering new highs 166 to 23. That 143-spread of new lows over new highs is the widest since Feb. 11, 2016, when there were 674 new lows vs. just 32 new highs.”

According to the folks at barchart.com, on a year-to-date basis, there are 124 stocks listed on the New York Stock Exchange that have set new lows versus a meager 41 that have set new highs. This historical breadth of the market indicator may have been corrupted by the corporations that are able to restore their stock’s ability to set new highs by buying back their own shares.

Last month Steven Pearlstein wrote at the Washington Post that stock buybacks are setting the U.S. up for the next debt implosion, since a major part of these buybacks are financed with debt. Pearlstein said “Corporate America, in effect, has transformed itself into one giant leveraged buyout.”

One major reason that this stock market bubble refuses to pop may reside in the willingness of the Federal Reserve to green light massive stock buybacks by the mega banks on Wall Street, which allows them to perpetually pump up their own share prices, making their equity capital appear strong enough to lend hundreds of billions of dollars each year to other mega corporations to buy back their own respective stocks. Leveraged buyout indeed.

When the history books are finally written on this dysfunctional finance era, expect the Fed and stock buybacks to warrant at least a chapter each.

Richard Henry Suttmeier, a contributor to Forbes Intelligent Investing columns, has his own list of “fundamental reasons for concern” about this stock market. They are:

  • “The four ‘too big to fail’ money center banks and the top five super regional banks are in correction territory and are beginning to fall below their 200-day simple moving averages. You cannot have a bull market for stocks with a bear market for banks;
  • “The housing market has stalled at 50% of potential with the major homebuilder stocks in bear market territory. Home prices are too high, and banks are reluctant to lend via a home equity line of credit even as home prices rise to record highs;
  • “Investors should be worried about a trade war as the tariff situation spreads;
  • “The Tax Cut and Jobs Act has left Main Street worried about what the implications may be given State & Local Income Taxes and property taxes. This is slowing consumer spending;
  • “Record High Margin Debt: At the end of May margin debt was above $650 billion, up 2.6% from April. When stocks decline many investors will be forced to add funds to their accounts to satisfy a margin call. If a stock owned on margin falls below $5 a share most brokerage firms will force the investor to pay for the stock at 100%, or face liquidation. A bear market thus accelerates during periods of margin selling as it did into March 2009.”

Wall Street veteran and banking historian Nomi Prins has also raised serious warnings. In an April 26 column at TomDispatch.com, Prins writes:

“So, today, we stand near — how near we don’t yet know — the edge of a dangerous financial precipice. The risks posed by the largest of the private banks still exist, only now they’re even bigger than they were in 2007-2008 and operating in an arena of even more debt. In Donald Trump’s America, what this means is that the same dangerous policies are still being promoted today. The difference now is that the president is appointing members to the Fed who will only increase the danger of those risks for years to come.

“A crash could prove to be President Trump’s worst legacy. Not only is he — and the Fed he’s helping to create — not paying attention to the alarm bells (ignored by the last iteration of the Fed as well), but he’s ensured that none of his appointees will either. After campaigning hard against the ills of global finance in the 2016 election campaign and promising a modern era Glass-Steagall Act to separate bank deposits from the more speculative activities on Wall Street, Trump’s policy reversals and appointees leave our economy more exposed than ever.”

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