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.

stockmarketcrashof2016China

Source: Bloomberg

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.

 

Read Next Investing 101: Introduction to Contrarian Investing

  • PeteyBrian

    In 2007-2008, I warned an ultra high net worth investor who had their entire liquid net worth in money markets of only one US bank to diversify to many banks/brokerages (keeping in mind FDIC limits) and/or into many different types of bonds (Certificates of Deposits/US treasuries/Municipals/Corporates) for their safer money. She didn’t heed my advice.

    Years later she confronted me – telling me that I was wrong when I said her bank could default on her large bank holdings. I responded that the bank she had her money in DID fail, but that the US Government BAILED that bank out. If they didn’t bail out those troubled banks/brokerages, she could have had lost most everything! She didn’t believe me, of course, and thanks to the USA – she didn’t have to experience this loss.

    In 2008 and 2009 most large U.S. Financial institutions did fail. Only a $2 trillion bailout from the US government, and changes to the accounting rules – allowed the banks and brokerages to remain solvent as many banks/brokerages were levered as much as 30 times cash on hand and with the US housing market asset prices also in freefall. Leverage is great when assets prices rise, but when asset prices fall – watch out!

    I was shorting US financial indexes around that time – was a bit early so I lost some value initially, then doubled my money towards the bottom of the financial crisis – then I got greedy and maintained my shorts when I should have just closed out my profits – later giving back much of my gains when word of the financial bailout occurred and the banks exploded to the upside as insiders and people in the know prospered. Guys like Warren Buffet with his big bet on Goldman Sachs – looks smart from the outset – then you realize that he’s connected with President Obama and was in on the meetings on how to fix the crisis which included bailout discussions… Then you realize that the rich and well-connected in the know investors – benefit from their acquired “knowledge.” Lol!

    • Harald Baldr

      “then you realize that he’s connected with President Obama and was in on the meetings on how to fix the crisis which included bailout discussions”

      No doubt about that. It’s the main reason I like his company Brk-B. He always vocally support big government and the establishment’s candidates at elections. A week ago he came out in support for Hillary Clinton. Naturally they shower him with favors and goodwill in return. It’s the same story with the Keystone XL pipeline which would hurt his railway freight business. Naturally he’s the main benefactor behind the derailing of said project and the reason it never gets the go ahead.

      You want your money riding on said winning team even if it runs against your political persuasion (which it does in my case).

      • PeteyBrian

        Agreed! I’ve never owned BRKB so I’ve missed some great returns over the years.

      • PeteyBrian

        A couple of value add points for consideration:

        I’d need to research their succession plans with Warren Buffet and Charlie Munger being older than dirt. Lol. Or see if I can look into my crystal ball and determine what manager will be the next Berkshire Hathaway.

        Also – the fund is so big now after all the years of success, that perhaps it will perform more in line with the markets especially since it’s harder to find deep value in today’s large cap markets big enough to make a difference. Alternatives might be a cheap S&P 500 index Exchange Traded Fund from say Barclays bank or a cheap mutual fund index fund from say Vanguard.

        • Harald Baldr

          Their whole corporate culture is solid and whoever comes after will be a cut of the same cloth. Look at Apple, they’ve surged on after Tim Cook took over. Don’t see why Berkshire can’t do the same. Only question mark is of course if he will be able to buddy up with the power structure the way Buffet has. That may be impossible.

  • disqus_q14bh9K8Yv

    Let’s ponder the suggestion that the markets would crash would investing in Index Funds long term still be viable? Specially Index’s in the US?

    • Harald Baldr

      Yes. There’s never a better time to get in than during a crash. Of course timing the bottom and predicting the length of a downturn is impossible. Historically the US market goes down swiftly but rise slowly over a longer period of time.

      One popular strategy many use is to Dollar cost average meaning they buy in at pre-set intervals. Let’s say every 3 or 6 months as markets tank.

      • disqus_q14bh9K8Yv

        How about the now moment? Or is it wiser to wait later in to 2016?

        Thank you for recommending me the little book of common sense Harald!

        • Harald Baldr

          I would wait for a more favorable entry point sometime next year were I you. It will likely be a volatile year with some big swings and hopefully some wild panic phases. There’s no meaningful correction going on as of yet. Take the time to continue learning and never rush a decision to buy. Wait until you believe you see a good buying opportunity that rhymes well with your investment horizon.

          You certainly started at the right place by reading The Little Book of Common Sense Investing 😉

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