Forecasting market tops and bottoms is impossible. The surest way to lose one’s credibility is to come out strongly in favor of an event that never arrives. Still, with so many people on the sidelines, waiting for the buying opportunities that ultimately arise when markets tank, I thought it overdue to look at some oft-cited factors that may spell imminent doom for this current bull.
The four most widespread a-crash-is-imminent arguments
First, the average American expansion post world war II ran for 58 months. That doesn’t necessarily have to mean anything in and of itself as cycles don’t die of old age. It does, however as Wall Street Journal noted earlier this week, make the current business cycle, at 78 months;
longer than 29 of the 33 expansions the U.S. economy has experienced since 1854
Over half the economists surveyed for the same article expected the fed-funds rate to be back to zero within 5 years. In layman’s terms, they expect interest rates in America will come back down rather fast. 15% even expected negative rates, i.e. you must pay the bank money to lend it to them. Clearly the jury is out on whether the American economy can tolerate the end of free money. The uncertainty of the effect rising rates will have plus the length of the current expansion then suggest that the end is nigh. When the real economy begins to struggle, so will the stock market.
Second, the unorthodox monetary policy since the 2008 financial crisis have likely pushed markets higher than fundamentals dictate. The current American bull run started the day quantitative easing was announced. The question is then where the S&P 500 would be without the endless rounds of stimulus? And can it survive without it? Turn on CNBC and you’ll see plenty of people arguing both for and against. Chances are though that several companies are:
A) carrying debt burdens that are unsustainable when (if) interest rates rise meaningfully
B) relying on customers who may cut back on the use of their products and services when mortgage payments starts eating up a bigger slice of their monthly paycheck
The implications at some stage will then be weakening profit margins and higher debt servicing costs. This will put downward pressure on said stocks.
Third, the slowdown in China will wreak havoc on markets around the world. Although this story has been known for a few years, people still rail on about it. Rather than debate the ins and outs of every facet of it, I’ll focus on a single chart.
Forget about how China manipulate its economic figures and let’s just take the numbers at face value. In 2008, China grew at 11.5% vs 7% in 2014. So the slowdown is evident for all to see. But it’s not as severe, or even much of a slowdown at all, once you account for the size of the economy. Here’s why:
In 2008 the Chinese economy (or GDP) was 4.55 Trillion USD. Growth ticked in a 11.5%, which means the added economic output that year worth 523 billion. In 2014 GDP was 10.3 Trillion USD. Growth was 7% which means the year’s added economic output was worth 700 billion. China is thus adding more economic value to its economy annually than before. But seeing as it’s larger in size, it’s impossible to keep the percentage figures as high as in the past.
As to the legitimacy of China’s figures, no one really knows, but suffice is to say that the common China is slowing down as it’s not growing at 10% like before narrative is false. It’s therefore safe to say that as of yet, China is far away from having ground to a halt as some people use the GDP growth figures to argue.
Fourth, oil tanked before the financial crisis. Since it’s in depression territory once again this proves another crash is coming. This is the least credible of all the crash arguments as the current decline is due to supply side forces. The market is oversupplied with oil as a result of an intentional price war low-cost OPEC producers are waging against high-cost shale and offshore producers. In 2008 it was a different story. Today’s lower oil prices are good for consumers and the economy as a whole.
How deep will markets fall?
Of the four then, neither age, oil or China will kill the bull. A recession would, but since growth have been anaemic at best and we haven’t seen an investment bonanza, the bull market could possibly simmer on for a few more years. As soon as the data, likely a quarter or two before, shows the US is in a recession the market will turn south. Absent that only an unpredictable blow, a black swan that catches everyone off guard, will cause investors to hit the panic sell button. Timing such a moment is impossible.
Generally what derails a market (other than recessions) isn’t what is known, but the unknown. Particularly the unprecedented.
The crash of 2008 were so severe as there were credible data and real fears that suggested the entire banking system would collapse, taking everything else down with it. It’s unlikely that a similar level of panic, meaning the whole index dropping 50% or more, will occur during the next downturn lest the market face a perceived systemic risk. Those are rare so a milder drop is more likely.
Given a 20-25% drop in the Dow Jones Industrial average there will be some juicy opportunities. If that happens in 2016 I will pick some old favorites and buy at 6 month intervals. If Warren Buffet’s Berkshire Hathaway (Brk-B) fall by that much from its current level of $130, it will be my first buy. It may also be my last. Only if Alphabet (GOOG) goes down more in percentage terms will I be buying them too.
If a rare but still possible full blown crash occurs with panic in all sectors I will consider other individual stocks at the expense of the aforementioned bluechips. Absent another downturn I will remain calm and continue hoarding cash in anticipation of future opportunities. Patience is a virtue and I will never again buy simply for the sake of buying or having too much cash outside of the market.