Why Another Stock Market Collapse Could Be Imminent

A lot of commentators have begun heralding a new bull market in stocks. Day after day, I hear that March was THE bottom, that the next bull market has begun, and that anyone betting on another collapse is a moron.

These claims are not only wrong, they are completely misleading and should be depicted for what they are: nonsensical hype from sources with conflicted interests - folks whose jobs and income stem largely from people remaining bullish.

More often than not, these are the same guys who claimed that Bear Stearns marked the end of the Financial Crisis (how’d that work out?) and that the Federal Reserve can pump our way back into a bull market (how’s that working out?).

The reason this is entirely wrong is because this recession is not your average run of the mill excess inventory recession: the kind of economic contraction we’ve experienced post-WWII.

No, this is a DE-flationary debt collapse, a bursting of a 30-year credit bubble that papered over enormous drops in real incomes, standards of living, and financial stability. The private sector hit a point of total debt saturation in 2007

This recession so far has been the first taste of DE-flation the US has experienced since the ‘30s. Comparing it to every other post-WWII recession is like comparing apples and oranges. A debt bubble cannot be re-flated by issuing more debt. A second-grader can understand this. I don’t know why guys with PhDs, alleged experts, and the like don’t get it.

For 30 years, our economy grew by borrowing from the future. I mean that the US’s economic growth was funded largely by the use of credit: borrowings that would be paid back down the road.

In simple terms, the economy grew based on imaginary, not REAL demand. We pulled forward future sales of cars, TVs, homes, and the like. By using credit, we bought things NOW, that we would have normally bought LATER. This pulled future sales, future corporate earnings, future incomes, and future economic growth to the NOW through the ‘70s, ‘80s, and ‘90s.

So instead of having a safe, annual rate of consumer spending growth (say 4-5%), we saw double digit rates of growth: for example, between 1980 and 1990, credit card spending increased more than five-fold while average household credit card balances quadrupled. That’s NOT normal.

This led to the single largest debt bubble in history ($49 trillion in private sector debt and $50+ trillion in public sector debt). And a debt bubble can continue until you can no longer meet debt payments. The private sector hit its “debt wall” in 2007. The public sector continues to grow its debts, creating an even larger bubble that will have even worse consequences.

Now, as you know, there are only two ways of dealing with a debt problem:

1) Paying it off

2) Defaulting.

The US consumer has begun both. From February to May of this year we paid off $45 billion in credit card debt. Consumer credit contracted $3.3 billion in May, the fourth consecutive monthly decline (this makes our current credit contraction the longest running since 1991).

And we’re just getting started…

Total consumer debt at the bubble’s peak was $2.57 trillion (the other $46 trillion was corporate). So the fact we’ve paid off about $50 billion of this means Joe America has a LOT more (98%) debt to pay back and default on before he’s finished de-leveraging his balance sheet.

Folks, we’ve got a long, LONG ways to go before this crisis and Crash are over. Anyone who’s telling you the bear market is over either isn’t looking at the data or is basing their analysis on “a gut feeling” or some other nonsense. They’re all going to get destroyed this fall.

Above, we detailed the difference between this current economic contraction, and your usual run of the mill plain vanilla recessions. We also went over the MASSIVE consumer credit contraction that needs to occur before American households have finished de-leveraging.

Now, we’re detailing why stocks will crash this coming fall. As you know, the media is rife with folks calling the end of the recession and the beginning of a new bull market. It’s clear to me that this is a load of nonsense. I’ll show you why.

Because a lot of the alleged “analysis” that is backing up the bulls’ claims of a new bull market comes from technical analysis and charts, I’m presenting the below chart from David Rosenberg of Gluskin Shef. It charts today’s bear market over that of 1929-1932.

As you can see, today’s bear market is mirroring that of the ‘30s almost to perfection. Indeed, the correlation between the two charts is an incredible 0.8, meaning it’s 4/5ths perfect. In finance, you’re lucky if you get a correlation above 0.6. (gold and the dollar are only 0.28 inversely correlated). A 0.8 correlation is virtually unheard of. But that’s exactly how closely today’s market is mirroring that of the ‘30s.

I can’t take full credit for this insight. Ron Coby, an investment manager at Coby Lamson in Oregon, first started pointing out the similarities between this market and that of 1929 back in February ’09. No one wanted to listen to him then.

They’re listening now.

Coby notes that from October 29, 1929 until November 13, 1929, the stock market collapsed 49% (2008's was 52%). Ron points out that the market then staged a 155-day rally of 50%. Today’s rally (starting in March ’09) has lasted 150 days and the market is up an average of 50% (average of Nasdaq, DJIA, and S&P 500).

Unfortunately for the bulls today, the 1929 market then rolled over and collapsed another 70%. “Bottom callers” INCLUDING legends like Jesse Livermore, Benjamin Graham and others bought ALL THE WAY DOWN, losing entire fortunes.

Ok, so the charts for today and 1929 are identical, what about the earnings? After all, profits are ultimately what drive the stock market: you buy based on expected future earnings of the companies.

Earnings today are even lower than they were in the ‘30s during the Great Depression. They’ve fallen 98% from their peak in 2007. Adjusted for inflation, stocks have NEVER been this unprofitable in the last 80 years.

The US was already in a recession in 2008. And 2Q09 profits are actually down 31% even from THAT. Indeed, based on ACTUAL posted earnings, the S&P 500 is trading at a P/E of 700 today. Even if you go by operating earnings the multiple is still 24: hardly cheap.

Looking over this, I can’t see where any claims of a “bull market” are coming from. The people who are saying today is a new bull market probably went long Tech Stocks in 2001, Housing in 2006, and Financials in 2008.

In light of the rampant bullishness, the parabolic rally in the S&P 500, the horrific earnings, and the similarity between today’s rally and that of 1929, I believe the likelihood of another Crash (like 2008) is quite high. In fact, I would not be surprised to see stocks collapse within the next eight weeks.

Comments

[ricom:]

Bulls make money, bears make money, pigs get slaughtered. I believe this market is experiencing a high bounce prompted from a large fall (March -09). The ball will come back down.
www.shopricom.com

Aug 09 01:45 AM

[QuasiYoda:]

A smart man knows market history, fundamental analysis and technical analysis. As you pointed out the almost 50% rally then technical analysis is what we will use here. Markets don't go in a straight line. They move in a primary direction then they retrace typically following natural mathematic patterns retraces tend to be 38.2%, 50% or 61.8% these are known as a Fibonacci Retracement. We have retraced nicely we could go up to a 50% or a 61.8% retrace but odds are we will retest that low and considering the dysfunction in the world today break and start a new leg down.

Did you really think the appropriate response to too much credit is . . . . more credit? Bernanke is basing his reaction to today's calamity in a totally fiat based economic system (US astronomically in debt) on what was done in Gold and Silver based monetary system (US creditor nation)? Sorry people I wouldn't get my hopes to high that all the right moves are being made. Today's economy is so much more complex than in days gone by but chart action, market psychology and the mathematics of natural phenomena still resonate as they always have.

Did you think the market could work out all of it's imbalances in 6 months? Especially when the smartest minds, most powerful groups (banksters, Presidents, Congress etc) all are doing everything they can to avoid doing what must be done and experiencing what must experienced ? No. But the reality of the damage done, the excesses taken on, the corruption embraced etc will come to the forefront once again . . . . and that right soon.


On Aug 05 03:41 PM CLH wrote:

> A smart man knows that making money is the name of the game. The
> market is up nearly 50%, if you are too frightened to buy then dont
> read garbage like the above.

Aug 09 07:14 AM

[limaur24:]

The "garbage" appellation arises from the fact that Mr. Summers is re-iterating what a thousand others have already said. The originality factor here is way below zero and the motivation for this "nonsense" is therefore highly suspect.
My neck was saved by a blogger, one who seems to have lost all interest in the subject of the causes of this crisis, but one who wrote about its build-up extensively BEFORE the fact. So I do not automatically discount what I read ,but I do try to relate it to a context .
By the way, the guy who saved my neck is Todd Harrison, and I never even bothered to register at his website.


On Aug 05 06:39 PM Genti Cici wrote:

> Your comment makes no sense, "The name of the game is making money"
> Ok, we know that, AND???
>
> And it's the opposite of what you say : IF I am frightened to buy
> I would want to read "garbage" like this so I know if my thinking
> makes sense. And if it makes sense, and someone can explain it better
> than I can then I should read that, right. Not, not read it.
>
> I thought we had a math problem {www.washingtonpost.com...}
>
> in our society, but I guess English is not our strong point either.
>

Aug 09 11:23 AM

[Pauly B:]

If we have a projected 2-3 Trillion dollar government debt doesn't that mean less money for me as a consumer to spend on good and services since I as a taxpayer am servicing this debt? I really dont think that is great news for the market do you? Somehow the talking pundits dont talk about this massive expanding of government intervention and its effects on the market.

Aug 09 02:29 PM

[Marvin Clark:]

There were upside rallies throughout the 1930's for stocks. It did not negate the fact that we were in a secular bear market for stocks and that we were in an economic depression. The same is true today. It will take years before the collective balance sheets of the US becomes sound again. Meanwhile, enjoy the casino boys, but there are no free cocktails.

Aug 09 03:06 PM

[Northstar10000:]

The market is going up because there is no place else for the MOMENT for cash to go. Once an asset class starts a move money flow into it and away from stuff that is not. Bond and money market have a negative return based on actual inflation. Commodities are down and there is not a single strong liquid currency worth owning.
Real Estate is in the tank so money goes to where money is forced to go. the music will stop very shortly and something else will suck money out of stocks. My guess, the dollar rallies fooling everyone, thus tanking stocks. Money for a short time flows into the dollar and gov debt. Watch it happen.

Aug 09 03:08 PM

[Buckoux:]

Amen.


On Aug 05 04:10 PM User 353732 wrote:


> "3. ..........A great majority
> of Americans continue to believe that the Govt is external to the
> economy and that it is a bottomless magic well. The Govt, Wall St
> and Media encourage this belief or rather cruel delusion because
> it is the very basis for issuing fantasy money.
> All economic delusions ,of course end, either when the spell is
> broken or when the delusion consumes the entire substance of the
> deluded.
> Reason and self control can end an economic delusion. So can enforced
> and prolonged destitution and servitude."

Aug 09 04:07 PM

[tracky57:]

Great thoughts here, well thought out, you are absolutely right, "rinse, lather, repeat," there is no sane reason for this rally.


On Aug 05 09:45 PM vicelord wrote:

> The one thing that you're failing to take into account is the - how
> to put this? - blatant manipulation and propping up of the market
> being conducted in broad daylight through the Supplemental Liquidity
> Provider program being run by GS. Otherwise known as the Plunge Protection
> Team. There were no super computers in 1932; there was no High Frequency
> Trading; there were no Dark Pools and no bottomless barrel of dough
> at the Fed window for the likes of JPM, GS and BLK to pump taxpayer
> money into equities. $4 Trillion so far has bought us a 45-50% rally
> on the S&P (and counting.)
>
> I have been grappling with this question for MONTHS now, after getting
> squashed like a bug in May trying to short too early. I, and I don't
> think ANYBODY, thought it would go this far. We've jumped about 135
> points on the S&P in roughly 2 weeks without even a mild correction.
> So, with that in mind, the question remains - if they can get away
> with pumping the market up this far, who's to say they can't keep
> it up here? Or at lease forestall another plunge to the March lows
> or lower? It stands to reason that if, with all the computers doing
> the trading, and the average retail investor out of the game, and
> volume being what it is, they could get it up this far, they might
> just be able to keep it there. At least make it trade sideways for...
> years? Who knows?
>
> I know it's ludicrous to buy at these prices. Every bit of data that
> comes out is either counter-intuitive to a bull market, or manipulated
> in such a way as to make it seem like a recovery is on the way. (Shit,
> today there was a piece in the Financial Times today about how Prime
> Loans in default or delinquency are up 13.8% from March - June, and
> this was from a study done by S&P itself. These are PRIME LOANS
> we're talking about. Up 13.8% during the same exact time we had a
> 40% market rally. But you didn't hear a peep about it on CNBC. Shocking,
> I know.)
>
> They'll come out with some optimistic unemployment numbers one week,
> and the market will rally 2% on the news that day... and then a month
> later you get an upward revision on those same numbers pouring cold
> water all over any hope. Lather, rinse, repeat. Where does it stop?
> When does it end? Every word that CNBC says or puts into print should
> come with a disclaimer saying they are owned by GE. There are too
> many people with a vested interest in inflating another bubble. Even
> the NYT and the WSJ have to play it cool, lest they end up with their
> stocks trading on the pink sheets for pennies.
>
> My question is can the powers that be that have run up the market
> from the March lows keep it from falling back down? Or is there a
> collapse coming that is inevitable and no one can stop, no matter
> how powerful their computers are or how much taxpayer money they
> have to play with?
>
> I just don't know.

Aug 09 08:00 PM

[Von Jenkins:]

I agree that it is too early to be wildly bullish! The levels of debt in the US & UK are extraordinary. The money printing machines have been going 24/7 and there is nothing backing our paper money nowadays. Some nice profits have been made on selected equities in the last few months, but surely a correction is due. Interest rates will start to rise soon. In the short term the equity markets are looking "toppy".


On Aug 05 03:07 PM Dave Wrixon wrote:

> Why do you think Autumn is called Fall?

Aug 10 12:03 AM

[Michael und...:]

I would also like to know why companies can claim a loss based on not getting "projected earnings" yet still claim a profit on the books


On Aug 05 04:13 PM ZotTower wrote:

> What is the difference between "ACTUAL posted earnings" and operating
> earnings?

Aug 10 12:05 PM

[DonFurio:]

You can call this whatever you want to call it, but I've been buying all year much to the dismay of the whiners, losers and shorts. Will there be a correction at some point? Who knows, who cares, because if you buy every month and have a couple of years time horizon, you should be fine.

The author is wrong about the debt, you can also inflate it away. The reality is that things are getting better. Will there be more bankruptcies ahead, sure, but a lot of those loans/bonds are priced to reflect that. Are things great right now, no, of course not, but if you are college educated and willing to relocate, there are jobs. Now if you if live in a town that relied on GM or some other plant and got to reap the benefits of the union demanding too much all these years, then yea you have some tough times ahead and should relocated / switch careers.

Aug 10 01:23 PM

[PartyConnect:]

The fed spent a ton of money because of how the bankers screwed up everything. We will be back to where we were it will take another 2-5 years.

They buildt all these condos that are empty. One guy in Florida has a whole building to himself. He tried to get his money back. No dice.

Too many condos that are now empty. That was the problem. I think they should all be in prison. Who allowed this type of fininacing to go crazy?

Aug 10 05:02 PM

[Grouchox:]

:::Unfortunately for the bulls today, the 1929 market then rolled over and collapsed another 70%. “Bottom callers” INCLUDING legends like Jesse Livermore, Benjamin Graham and others bought ALL THE WAY DOWN, losing entire fortunes.:::

You got it wrong. Jesse Livermore predicted the 1929 crash, like he did with the 1907 crash. He shorted stocks in 1929 and made $100 million during the crash. Not too many people can claim that! Jesse Livermore lost his money by following tips from his close friends and disobeying his own trading rules. He lost his fortune several times and always made it back.

Aug 10 05:34 PM

[CAPITALIZER:]

Graham, I really think this is a well researched and structured piece that makes total sense to me. I think however that every honest analyst and business writer that predicts a crash this fall has not factored in what we're seeing right now; the full power of a protective pro-socialist government in collusion with elite world bankers and the mass business media sending out bull-tard waves across the entire planet earth. If a crash will suit their needs to grab more power we're gonna see it but if thet want stabilization, even if it goes against the laws of physics they are going to make it so.

Aug 10 10:07 PM

[HRahimi:]

I think you might be correct with your line of thinking.
However, I think precious metals are a better safe haven than stocks and silver is extremely under valued relative to historical demand and supply.
It is also a matter of maintaining purchasing power of your capital so investing into stocking that are making losses isn't exactly "smart money".


On Aug 06 11:27 AM Albert Ling wrote:

> Even if the economy worsens, cash is still not the place to be, eventually
> the trillions of new money created will appear and devalue cash,
> bonds, any kind of nominal debt and savings. So only place to be
> right now is real assets (stocks). "smart money" investors know this
> obviously and that is why the market is rallying.

Aug 11 02:52 AM

[heyjoe:]

1 major difference, the government didnt step in with a bunch of spending stimulus programs... that is where the correlation to the GD comes in because that is the route we took then.


On Aug 05 03:07 PM Angel Martin wrote:

> I think the most relevant historical example is the stock market
> rally of 1921, not 1929.
>
> (1918-1921)
> War - inflation - real estate/farmland bubble - disinflation - real
> estate crash - stock market crash - financial failures - severe recession
> - stock market rally - economic recovery

Aug 11 01:09 PM

[billymadisun:]

is there a way we can track this chart mirroring the Great Depression's performance, present day day-to-day?

Aug 11 06:08 PM

[john s. gordon:]

russ w. -
economic recovery in 1921-27 in the u.s was because everyone in the world (esp england & france) owed us money, & some repayments were being made.
in 1927 farm commodity prices collapsed (the war ravaged countries of europe were finally able to feed their people) and a major source of income to the u.s economy was cut off. same happened in canada & argentina, major food exporters in the 1920's.
> jack

Aug 15 06:16 PM

[RiskAverseA...:]

The technical case pointing the stock market's intermediate-term path of least resistance lower is rather compelling. Yet just when the market might crash -- indeed, whether a crash might even be forestalled -- remains a mystery no matter the past, and no matter whether you feel as I do that, March bottom in all probability will fail.

Considering how bad were the market's internal readings last year -- for example, NYSE new 52-week lows were of a multi-generational magnitude -- it's possible further selling along the path of least resistance (lower) over the next few years might never accelerate as rapidly as we saw last year, yet over the duration major indexes might still be clobbered back to levels last seen 15-20 years ago.

Aug 30 09:51 PM

[User 280412:]

graham, i read with interest this article that you wrote and started following your blog since. however, there's now a trend divergence between the dow now and during the great depression. do you now think that this comparison is invalid? or do you still subscribe to the view that the market is still mirroring the great depression era and a collapse will come to resume tracking the great depression trend again?

Nov 16 05:48 AM