Why Stocks will Crash
“Things always become obvious after the fact” – Nassim Nicholas Taleb
“Facts do not cease to exist because they are ignored.” – Aldous Huxley
The S&P 500 currently stands at 2,126, fractionally below its all-time high. It is now 300% above the 2009 low and 34% above the 2008 and 2001 previous highs. Most people believe this is the new normal. They are comfortably numb in their ignorance of facts, reality, the truth, and the inevitability of a bleak future. When the herd is convinced progress and never ending gains are the norm, the apparent stability and normality always degenerates into instability and extreme anxiety. As many honest analysts have proven, with unequivocal facts and proven valuation measurements, the stock market is as overvalued as it was in 1929, 2000, and 2007.
Facts haven’t mattered, as belief in the infallibility and omniscience of Federal Reserve bankers, has convinced “professionals” to program their high frequency trading supercomputers to buy the all-time high. If central bankers were really omniscient and low interest rates guaranteed endless stock market gains, then why did the stock market crash in 2000 and 2008? The Federal Reserve’s monetary policies created the bubbles in 2000, 2007 and today. There was no particular event which caused the crashes in 2000 and 2008. Extreme overvaluation, created by warped Federal Reserve monetary policies and corrupt Washington D.C. fiscal policies, is what made the previous bubbles burst and will lead the current bubble to rupture.
Benjamin Graham and John Maynard Keynes understood how irrational markets could be over the short term, but eventually they would reach fair value:
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” –Graham
“The market can stay irrational longer than you can stay solvent.” – Keynes
Graham’s quote reflects the difference between hope and reality. This explains the ridiculous overvaluation of Amazon, Shake Shack, Twitter, Linkedin, Tesla, Google, and the other high flying new paradigm stocks. Story stocks soar because the herd believes the stories peddled by Wall Street and company executives. Five of these six stocks don’t have a PE ratio because you need earnings to calculate a PE ratio. In the long run the market will weigh the value these companies based upon profits and cashflow. It is the same story for the market as a whole. There is no question who is to blame for what now amounts to a three headed hydra of bubbles poised to burst.
The Federal Reserve has simultaneously blown bubbles in the stock, bond, and real estate markets by keeping interest rates at 0% for the last six years, three rounds of QE money printing that created $3.6 trillion out of thin air to prop up the insolvent Wall Street banks, and unending jawboning about inflation being too low as real middle class wages stagnate at 1989 levels. There isn’t a question about whether the bubbles exist, only about how much bigger they will become before bursting again. As John Hussman points out, the financial stability of the world will be endangered when the bubbles burst this time.
“Unfortunately, the Federal Reserve has now created the third financial bubble in 15 years. Focusing on two variables – inflation and unemployment – the Fed has missed the most important consideration: the risk to financial stability. It is the same mistake the Fed made during the housing bubble. This mistake will ultimately end just as tragically. The only question is how much worse the Fed makes the situation in the interim.”
The mouthpieces for the vested interests on Wall Street and slithering around the halls of Congress, roll out their tired storylines about low interest rates supporting ridiculous valuations and corporate profits remaining permanently high because we’ve entered a new paradigm. We’ve heard it all before. Taking extreme risks based upon false economic beliefs, the infallibility of Ivy League educated academic bankers, and delusions of never ending gains produced by Wall Street HFT computers will end in tears for the third time in fifteen years.
The Federal Reserve began lowering interest rates in late 2007 from 5.25% to 2% by September 2008, and then .25% by January 2009. Did that prevent a 50% collapse in stock prices? Did it prevent national housing prices from plummeting by 35% between 2006 and 2010? The main reason stocks bottomed in March 2009 was the FASB bowing down to their masters and revoking mark to market accounting, allowing the insolvent Wall Street banks to pretend they were solvent. The combination of fraudulent accounting, zero interest rates and round after round of QE money printing has propelled this mal-investment mania to epic proportions. Total stock market valuation of $36 trillion now exceeds 200% of GDP. Prior to the Fed bubble blowing era, the total stock market valuation averaged about 50% of GDP.
Mark Hulbert, whose job at Marketwatch appears to be writing alternating bullish and bearish articles to keep the public confused, disoriented, and dependent upon hope and central banker heroine injections, produced the chart below showing corporate profits as a percentage of GDP. Corporate profits always revert to their mean. The capture of our economic system by Wall Street and mega-corporations is glaringly obvious in the increasingly higher peaks in corporate profits since the late 1990’s, as the Federal Reserve has provided the Greenspan/Bernanke/Yellen Put for the reckless Wall Street gambling casino and dangerously low interest rates encouraging corporations to issue record levels of debt in order to buy back their stock, fire workers, and ship jobs to low wage slave factories in the Far East.
Corporate profits as a percentage of GDP have averaged 6.3% over the last six decades. They deviate wildly above and below this mean, with peaks attained near stock market highs and valleys at stock market lows. The current level of 8.7% is two standard deviations above the 6.3% long-term average, meaning it is above 95% of all instances in history. Based on history, what are the odds of corporate profits rising to three standard deviations above the mean (99.7% above all instances)? Not good. They have already fallen from the 10.1% high in 2012.
Corporate profits have been juiced by Wall Street using mark to fantasy accounting, loan loss reserve manipulation, risk free Wall Street casino gambling with free money provided by the Federal Reserve, corporations refinancing debt, suppression of wages through global arbitrage by mega-corporations, government entitlement deficit spending, never ending wars in foreign lands enriching arms dealers, and expansion of the surveillance police state throughout every city, town, and hamlet in the good ole USA.
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