We have seen a nearly year long run up in the S&P500. Most believe this has been mediated by the Fed's quantitative easing programs. The mantra, "the money has to go somewhere", has led many to keep pouring money into both stocks and bonds. Many now think this has created a bubble. In point of fact, the margin debt is at an all time high at $384B (see charts below). It is above the historically critical 2.25% of GDP limit that has in the past marked a coming severe retracement (crash).
The charts show that the S&P500 started falling rapidly within a one year period after margin debt first reached 2.25% of GDP. History seems likely to repeat itself, so the S&P500 is on a countdown for a crash. The chart of the margin debt versus the NYSE below gives investors an idea of just how much the current market may fall.
As you can see, the market fell roughly 50% in each of the last two cases of the margin debt exceeding 2.25% of the GDP. I would not guarantee that such a fall is going to happen again. However, a substantial fall in the market does seem likely. The probability of such a fall is further backed up by the following fundamentals:
- The price of gold (and silver) has been going down, while central banks around the world have been injecting an incredible amount of liquidity into the world economy. The normal expectation from this central bank behavior would be inflation. The fact that this is not happening (and gold is going down) provides a strong indication that the world is facing a slowing world economy.
- The EU and the Eurozone are officially in recession. Both the EU and the Eurozone experienced their second consecutive quarter of economic decline in Q1 2013. This recession may well deepen significantly before the situation improves. For instance, Spanish youth unemployment is well above 50%. Its 27% Q1 2013 unemployment was the highest in the EU after Greece. In March 2013 the New York Times reported that Italian businesses had been failing at a rate of 1000 per day for the last year. There are only 6 million businesses in Italy. A failure rate of 365,000 per year is far too high. The now long term youth unemployment problem throughout southern Europe (and Europe in general) may lead to long term economic problems for the EU and Eurozone.
- The Chinese HSBC flash PMI for June 2013 fell to a nine month low of 48.3 for June. This was down from May's final reading of 49.2. Both of these readings indicate contraction. Many economists are worried that a slowing Chinese economy will lead to the bursting of the Chinese credit bubble. This is an ever stronger possibility that investors should be aware of. It is a worry that will pressure Chinese and world markets downward.
- India had sub 5% growth (4.7% and 4.8%) in the last two quarters. This meant it recorded a decade low 5% growth for its fiscal year ending March 31, 2013. With its high food and energy trade deficits, many are worried India will soon experience a crash from a credit bubble.
- Another of the BRICs -- Brazil -- is experiencing slow growth. Q1 2013 was its fifth straight quarter of slower than expected growth. It expansion decelerated to +2.2% per year. This was down from +2.6% in Q4 2012. Brazilians have been rioting recently against their government. Initially this was thought to be due to the increase in the public bus fare by +$0.10. However, this bus fare increase was rescinded, and the protests are still growing. This unrest likely indicates hard economic times ahead for Brazil.
- Renaissance Capital -- one of Russia's leading investment banks -- says the Russian economy will not be able to grow faster than 2% per year in the coming decade. It posits that Russia could easily become another Greece. Russia's GDP grew only +1.6% in Q1 2013. This was its fifth consecutive quarter of growth rate decline (the Federal Statistics Service). In April 2013 Russia cut its FY2013 GDP growth forecast from +3.6% to +2.4%; and it may yet go lower. In 2012 GDP growth slowed from 4.8% in Q1 to 4.3% to 3.0% to 2.1% in Q4. Q1 2013's +1.6% GDP growth continues this strong downward trend.
- North African countries and the Middle East are rife with rioting and warring. This often happens when economic times are tough. When there are not enough jobs and not enough food, the people are unwilling to put up with the extra restrictions of the governments. They think the governments are doing nothing for them (only for themselves).
- The US economic growth is also expected by many to slow in Q2 and later quarters. The US reversed the payroll tax cuts at the beginning of January 2013. This amounted to approximately an extra 2.90% in taxes for the average American. The rich were gifted with a few extra taxes just for them. There will be 2.90% less that middle Americans have to spend on consumer goods; and consumption drives the US economy. On top of that the Sequester was put into effect at the beginning of March 2013. This cut Federal spending, especially defense related jobs. It is expected to have a larger negative impact on the US economy as we move into 2H. Many other US economic indicators have been weak recently. Importantly the Q1 2013 reading for GDP growth came in at a weaker than expected +2.4% recently.
- Revenue growth for the S&P500 was relatively flat in Q1 2013. Before the start of the Q2 2013 earnings season, FactSet states that analysts expected EPS growth for Q2 2013 to be a meager 1.1%. In March 2013 that expectation was for +4.3% growth. Without the expected good results from the financial sector this growth expectation would now be -2.2%. Revenue growth is estimated to be a meager +1.2% for Q2 2013. Neither of these figures are awe inspiring. Either could easily fall from its current level. Both estimates have fallen significantly since March 2013. Earnings growth is still projected for 2H 2013, but little revenue growth is expected. I don't see how there can be good earnings growth without out any appreciable revenue growth longer term. Current estimates for revenue growth in 2H 2013 are +3.2% in Q3 and +1.7% in Q4. Given the fall in estimates since March the Q4 number could easily be negative by the time that quarter arrives. The US could follow the trend of most of the rest of the world into slower growth. Possibly the US could find itself in a double dip recession by early 2014. An US double dip recession would agree strongly with the technical result expected from the too high margin debt in the US equities markets currently.
None of the above reasons is by itself a weapon of mass destruction. However, together these items all add up to serious problems ahead for not just the US economy, but many economies around the globe. An implosion in the EU, India, Russia, or China could by itself cause a huge worldwide economic disturbance. Many dominoes are already teetering. It seems extremely likely that at least some of them will fall over. One or more of the troubled EU economies could start a world disaster. A cascade effect, especially in the banking business, could do untold damage. Credit could tighten as it did after the Lehman bankruptcy.
I do not want to go through that again. However, I especially do not want to lose more money, nor do I want my friends to lose large amounts of money. Readers should beware. The coming market volatility is likely to be large. One needs to have a viable strategy. The above is merely an alert on how important having such a strategy is. Yes, you can short things in a down market for good profits. However, this article is only the alert; and I do not wish at this time to answer any shorting questions.
The two year chart of the SPDR S&P 500 (NYSEARCA:SPY) provides some technical direction for this article.
The slow stochastic sub chart shows that the SPY is near oversold levels. The main chart shows that the SPY is still in a strong uptrend. However, that trend has weakened significantly recently. Given that the trend is about 1.5 years long, it is overdue for a big pullback at the least. The current pullback could continue, or not. The margin debt "imminent disaster" indicator is not easily timed. Past history shows that the large fall it predicts may take two years to fully materialize. There is really no dramatic technical information on the above chart you can use either. However, a prudent investor will want to move more heavily into cash at this time.
With interest rates rising quickly, now is probably not the best time to buy bonds. Yes, cash is a losing proposition, but with the hugely elevated risk of losing large amounts of money in both the stock market and the bond market, cash is not a bad alternative. Some good fundamental growth, value, and dividend plays are probably still appropriate, but the "nose bleed" stocks should be avoided. Remember too that one of the biggest and best bond trading houses, PIMCO, has had huge losses recently. If the experts are having that much trouble, the rest of us are likely to do even worse. The PIMCO Total Return Fund was down -2.2% on the year as of June 20, 2013.
NOTE: Some of the above information is from Yahoo Finance.
Good Luck Trading.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in SPY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.