2016 was expected to be a bearish year for global stocks, but no one expected just how quickly the overall market would deteriorate. The outlook turned bleak right out of the gate, as global stocks recorded one of their worst starts to a year on record. While markets have recovered favourably since mid-February, it’s still no reason to be bullish on stocks. According to a growing contingency of market analysts, a stock market crash is inevitable, and 2016 could be the year that the system finally begins to erode.
Blaming the Federal Reserve
When discussing the inevitability of a stock market crash, many observers immediately point to the Federal Reserve’s role in fueling an out of control financial bubble. It took the Fed $4.5 trillion and seven years of rock-bottom interest rates to orchestrate recoveries on Wall Street and Main Street. If you’re of the opinion that the Fed was largely responsible for the 2009-2015 bull market, you’re probably not surprised by the market’s behaviour since the FOMC’s famous December rate rise.
According to some estimates, stock prices are more than 30% above what the economic fundamentals suggest they should be based on a slew of historical indicators. If this model is correct, stock prices could plunge some 50% from current levels.[1] Also, the Fed’s apprehension about normalizing policy has not been lost on the market. Investors know the Fed is struggling to make sense of the murky picture. This doesn’t exactly illicit feelings of confidence about the future of asset prices.
Worrisome Indicators
In addition to the Fed, there are very tangible reasons to be afraid of a bigger pullback in stock prices. While some of these reasons may be difficult to accept now that stock prices have bounced, the volatile ingredients that dragged stocks down in the first place are still there.
- Investors betting against stocks: The Chicago Board Options Exchange has a put/call ratio that gives us a pretty good idea of how many investors are betting against stocks.[2] A put/call ratio above 1 indicates that more investors are betting against stocks. As you probably guessed, the ratio spiked above 1 in January and spent a considerable part of the first two months of 2016 hovering north of 0.80.[3] The last times the put/call ratio was around these levels was in 2011 and 2008 – two periods that were associated with a massive decline in stocks.[4]
- Surging gold prices: One of the most shocking developments of the past two months has been the relentless surge in gold prices. As the world’s oldest safe haven, gold offers protection during periods of instability. Gold closed above $1,270 per troy ounce on March 4, having gained a whopping $210 in 2016. Believe it or not, gold is now in bullish territory[5] and looks strong heading into the spring.
- Dismal corporate earnings: Wall Street is officially in an earnings recession. Blended earnings for S&P 500 companies declined for a third consecutive quarter in 2015 Q4, the first time that has occurred since 2009. What’s more, earnings are forecast to decline 8% in 2016 Q1, according to financial research firm FactSet. In fact, 91 companies have already issued negative earnings guidance.[6]
- Global volatility: The combination of weaker global growth and ineffective central bank policies doesn’t bode well for equity markets. China has been a major source of instability for investors not just in Asia, but in Europe and North America as well. The two biggest selloffs since the 2011 European debt crisis have originated in China. Investors should get used to this as the world’s second largest economy undergoes a painful transition that will take years to even out.
The Bigger Picture
The forces discussed above are likely to impact stock prices in the short term. Looking over the horizon, however, analysts are warning of an inevitable market crash that’s based less on current macroeconomic forces and more on “social transformation processes” that accompany advances in technology and institutions. It has been argued that human civilization is currently in the tail end of the third industrial revolution, a period that began in the 1950s and has been defined by advances in information technology.[7]
For the stock market, the third industrial revolution is defined by saturation and increasing competition, leading to a condition where only the strongest companies survive. This period is also defined by mergers and acquisitions and increasing financialization, which invariably leads to a decline in economic activity. We all know that declining economic activity gives birth to bitter recessions and central bank rescue efforts.
Here, we circle all the way back to the Fed and central banks in general. After all, it was the power of money printing and rock-bottom interest rates that got the United States and many other economies out of recession. As central banks run out of ammunition, economies face the real threat of breaking down, which would have catastrophic consequences on the financial markets.[8]
The Calm Before the Storm?
If the theory of the third industrial revolution has any merit, the picture looks pretty bleak. We’re already beginning to see the shortcomings of central banks several years after the 2008 financial crisis. It took the Fed trillions of dollars to bring the US economy back above water. The European Central Bank and Bank of Japan have embarked on trillion-dollar stimulus packages of their own in recent years, although they’ve been less successful.
More than a dozen central banks eased monetary policy in 2015,[9] a staggering figure if you stop and think about it. The stock markets certainly benefited from quantitative easing, but did they become too reliant on it? The answer isn’t clear, but the evidence seems to indicate so.
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[1] Michael Snyder (January 28, 2016). “Blame the Federal Reserve for Stocks Crashing.” TradingGods.net.
[2] Moe Zulfiqar (February 4, 2016). “Here’s Why Stock Market Crash Could Happen.” TradingGods.net.
[3] CBOE Equity Put/Call Ratio. YCharts.
[4] Moe Zulfiqar (February 4, 2016). “Here’s Why Stock Market Crash Could Happen.” TradingGods.net.
[5] Calm Investor (March 3, 2016). “Gold Is In A Bullish Flag.” Seeking Alpha.
[6] FactSet (March 4, 2016). S&P 500 Key Metrics.
[7] Value Walk (February 17, 2016). New Stock Market Crash Inevitable?
[8] Value Walk (February 17, 2016). New Stock Market Crash Inevitable?
[9] Bloomberg News (February 28, 2015). “China cuts rates again in face of weak demand, deflation risk.” Business News Network.
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