- Momentum has turned. So far the market has been saved over and over again by its own momentum, but the last week momentum has turned and now selling begets selling instead of the opposite.
- Everything is built on printed money and debt, which is just another way of saying it's all smoke and mirrors, an indian rope trick if you will
- Once interest rates normalize the game is over; it's only a matter of time (first, however, flight to safety will cause interest rates to fall)
- I think so
That's the short and the long of it. However, most people want more. Just note, that anything said about the stock market is just beliefs, never really truths. Anyway, here goes:
- The economy is built on debt:
- Governments are more in debt than ever
- Deficits are large despite 6 years of recovery - imagine what will happen with debts an deficits in a recession. Sooner or later taxs must increase to close the gap. That will hurt growth and profits. Considering the size of the debt burden, the breaking point is rather sooner than later
- Valuations are built on debt
- Investors buy stocks since nothing else has a return due to money printing, pushing up valuations
- Companies borrow and buy their own stock to manipulate earnings per share and compensate for stock options. These buybacks push up bothe EPS and stock prices, while lining companies with debt
- Investors' margin debt at the NYSE is at record levels - these will be called and thus create forced selling at a certain point
- Profits are misleadingly high
- Government deficits and transfers, food coupons etc mean people can keep consuming more than otherwise, despite low or no wages
- Low savings rate means companies can pay less wages while still selling more, thus earning more than they normally would. The savings rate is low, since people are used to financing their consumption with loans due to low interest rates (consumer loans, house loans, car loans, student loans). Neither individuals, nor the state will be able to afford paying for retirement without higher savings or higher taxes.
- Profits are artidicially high, since they don't account for true personnel cost (they are paid with stock options instead of cash)
- Profits are phony, since the large debts hardly affect profits, as long as interes rates are near zero
- The benign feedback loop now reverses
- Falling asset prices weakens confidence and leads to more selling
- Less collateral for loans mean less room for spending
- Companies will raise prices on what they can; necessities; leading to even less room for spending
- Less room for spending means lower profits, but also demands for higher wages and pensions,leading to even less profits and more public budget tightening
- Higher wages, pensions, taxes and higher prices means inflation and sooner or later higher interest rates
- Higher interest rates means less lending as well as higher loan service costs. This leads to lower house prices, lower stock prices, even less confidence etc...
Hence, in my mind it is only a matter of time before the economy, profits and valuations of these profits will join with reality again, With lower growth, lower profit margins and lower valuations of these lower profits, stocks should be worth at most half of what they are today.
Now, should and will are two different things, in particular when it comes to stocks. On the other hand, the stock market moves in cycles, just as most things do and when the market pendulum has reached its max and its momentum fades, the pendulum inevitably turns.
Momentum dies when a small correction feels big. After 6 years of relentlessly rising stock prices and ever smaller corrections, it takes "a lot" to shake investors' confidence and create sellers of buy-the dippers. On the other hand, the more debt is piled upon debt the less it takes to feel like "a lot". The current little correction of 10 per cent usually occurs at least once every year and should be nothing. Now however, many are panicking already.
Consequently, I think we are right on the edge of whether the big downturn has started or not. Just as Bob Janjuah said in his market call update today (Bob's World), if we close at the current levels for two weeks in a row (tomorrow and next Friday), confidence will be broken (confidence in the market, in the economy, in central banks, in politicians), selling will beget selling and the downturn will be confirmed.
There will be many, many bounces; dead cat bounces. Don't let them fool you. Sure, try to trade them if you feel like it. The market seldom drops more than 20 per cent in a straight line and seldom for more than a quarter, so try to buy some after similar plunges. Sell once it has bounced 10-15 per cent; don't go for more or you risk being locked out of the market fall. During the downturns of 2000-2003 and 2007-2009 there were tens of such bounces.
Maybe a bounce is already due; maybe we will fall another ten per cent first. In any case, I would use the bounces for selling, not the falls for buying. The market is now a bear market where you sell the bounces, not buy the dips.
Cheer up! If the market falls by half, you'll get the opportunity to invest at reasonable valuation levels. Good for you. The market has already fallen by 50 per cent two times since the peak in 2000; a third time won't break the global system or cause wars. Just be sure to keep some money at the ready, to be able to invest if the current rout does indeed turn out to be the beginning of the real downturn.