Why the Stock Market Will Crash Soon

The Fed says that there will be more rate hikes than Wall Street expected, and market watchers yawned.  Mr. Powell said that inflation is creeping up, and the Fed will nip it in the bud, and the S&P 500 goes up the next day.  Investors are assuring the talking heads that we are in a Goldilocks economy.  Twitter is near $47.  Strange things are indeed afoot at the Circle K.  All of this optimism and forward momentum can only mean one thing: The stock market must crash soon.

I don’t think anyone seriously entertains the notion that multiples aren’t stretched; with the S&P 500 back to within a few points of its all-time high and the NASDAQ is off on a parabolic run—again.  There is assuredly exuberance, but many claim it is rational and that there is a huge potential for upside.  The P/E for the overall index is somewhere around 25x.  That should be pretty scary, but for some reason, it is not.  The Bulls still hold sway, and valuations are stretched beyond reason.  The economy is doing great, I grant.  I also grant that when there is a hot economy, it tends to presage a reversion to the mean.  I’ve only heard mention that the Shiller P/E is around 33x.  In real dollars, that’s higher than just before the Great Depression and higher than just before Black Monday.  It has only been higher than it is now during one period in the history of the market (at least back to 1890).

There are many arguments as to what can stretch the benefits of tax cuts into 2019.  The underlying logic is that such stretched multiples require stellar growth to even come close to justification.  The tax cuts were a one trick pony when it comes to growth.   The idea that the tax cuts will produce enough capital expenditure to fuel enough growth to pay for them was a pipe dream, and with the frenzy of buybacks and mergers, we should be sure that it isn’t going to happen.  We are priced for a Goldilocks market with never-ending stellar growth.

Here is what Professor Shiller thinks about current valuations (when the S&P 500 was at 2,680):

The IMF says growth is going to slow down in 2019.  Warren Buffett is sitting on a huge cash hoard, something Berkshire doesn’t often do.  It makes one think a big stock sale may be coming on.  Ray Dalio sees “asymmetric risk” around the world, and a looming recession somewhere about 2.5 years from now.  Recessions, he points, out usually hit the financial markets around 14 months before you get to a full-blown recession.

The bottom line is that current valuations are beyond reason, and the various actual economic stimulants that the market has benefited from are starting to fade.  We may get one last big push from an infrastructure stimulus package, which we can ill afford.  Any further rise is due to animal spirits and not anything Ben Graham would approve of.  At this stage in the game, reversion to the mean is a matter of when and not if.  If you decided that you are an index investor in the last 8 or 9 years and have been pouring money into the S&P 500, then be prepared to realize what that strategy means.  You will be tested in the near future, and if you don’t have the iron will to stay invested when things get ugly, you should start getting defensive now.

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