As I enjoyed sipping on a newly discovered style of Scandinavian coffee (for those interested, it is cracking and mixing a raw egg into your coffee grind), something trending on Google searches for the long weekend caught my attention. “Stock Market Crash” kept popping up in most searched terms.
Now I was not too surprised since all the major US indices made new record highs on Friday. We usually see contrarian headlines like this.
But being someone who trades and observes the market on a daily basis, I was intrigued…and clicked to find out what the hype was all about. Two articles popped up.
One article was encouraging investors to buy Gold before the S&P 500 crash, with the headline “Make Gold Your Stash Before the S&P Crash“.
The author mentions that there really is no reason for a market crash since: Q4 earnings have been stellar, interest rates are pretty close to 0, Americans are using cash to buy stocks since they are limiting spending elsewhere, the vaccines rollout, and finally, the S&P 500 is still in an uptrend, and rule #1 for trading is that the “trend is your friend”.
And nobody can deny the uptrend in the S&P.
However, it seems the Biden effect has appeared to run its course. Last week we got some disappointing economic news. Both of them were unexpected by analysts. The first was US Jobless Claims (people claiming FIRST TIME unemployment benefits) came in 793,000 versus the 760,000 expected for the week. Yes, it is better than the 800,00 plus number the previous week, but all this talk of a V shaped recovery is falling flat, as last weeks data brings the total number of jobless claims due to the pandemic to 78 million, or close to 49% of the American workforce.
The second unexpected data print was that US Consumer Sentiment unexpectedly fell to 6 month low.
The author goes through some other data points related to Gold, Debt, Derivates and Debasement before concluding:
“This is to where we’ve arrived, folks. Be it the “Look Ma, No Earnings!” Crash, the “Dissemination of Misinformation” Crash, or merely the “No One Knows What the Hell to Do” Crash, something has to give, for ’tis what markets inevitably do. And the catalyst may simply be which investment bank is the first to blink: we’ve witnessed historically wherein one of them announces reduction of client equity exposure, and the market then goes over the cliff. (And this time, ’tis one heckova cliff…)”
But it really is about this second article that was trending.
The second article is from Forbes and the author goes through 11 key metrics comparing today’s market to that of the Dot com bubble in 2000. These 11 market metrics flashed warning signals before the dot com bubble crash. The rational is that with an army of retail traders (WallStreetBets and the Gamestop situation), SPAC mania, and with IPOs that more than double on the first day of trading, combined with a 12 year bull market are signs of irrational exuberance These are summarized, with a bearish or bullish indicator for today’s markets, below:
S&P 500 Shiller CAPE Ratio – Bearish
American Association of Individual Investors’ Sentiment – Bullish
The Volatility Index (VIX) – Bearish
S&P Market Cap Concentration: Bearish
Personal Savings Rate – Bullish (this one sort of surprised me, but I guess with lockdown measures, nobody really has much to spend on outside of necessities).
IPOs – Bearish
Buffett Indicator – Bearish
Put/Call Ratio – Bearish
Margin Debt to Cash – Bearish
Federal Reserve Assets – Bullish (no surprise here, and more on this in just a bit).
Federal Funds Rate – Neutral
If you want more information on how these metrics are measured, or what exactly do they mean, read the full article. The key take away here is that the Bearish signals outnumber the Bullish signals.
So it the Stock Market about to crash?
My long time readers have known about my stance on stock markets. In fact, I have been saying this since the markets fell last year in February during the everything sell off. There is nowhere to go for yield, and this is largely to do with the environment the central banks have created. Money is being forced into stocks.
There is going to be an ever increasing amount of cheap money from the central banks, as they continue to prop assets. Every central bank wants a weaker currency in order to boost inflation, which is why we are watching the currency markets as the currency war rages on. Let’s not forget the government side. Fiscal policy will continue to see trillion dollar packages and larger deficits. This means that interest rates will remain low for a very long time, and that a weaker currency is also favored by governments as these two things will help service the debt and pay it off with cheaper currency.
So even though the real economy is dying, and we have surpassed the Great Depression like statistics, none of it matters. Cheap money and central bank policies will prop it, until they decide to pull the plug. Some even go as far to say that the Federal Reserve’s Plunge Protection Team must not allow a major correction in markets due to the pension and retirements crisis’ which may create a snowball effect for the entire financial system. Pension funds have had to buy stocks in order to achieve their 8% return since that cannot happen investing in safe assets like they usually did in the past: bonds.
So in short is a stock market crash about to occur? Or put another way, will the Federal Reserve allow the Stock Market to crash? Not yet in my opinion, but this does not mean we get corrections. Currently, it seems people have a Pavlovian response to market drops: buy the dip.
However, there are two charts here that I want you all to keep on your radar…and one of them is slightly worrying.
The first is the 10 year yield (ticker symbol TNX).
As my readers know, the 10 year yield is my preferred way to gauge where the Stock Markets are going to go. When the 10 year yield moves up, it means that money is leaving the safety of bonds (An inverse relationship between bond prices and bond yields). Since most funds use the asset allocation model of rebalancing the stock and bond portion of their portfolio’s, we can assume that a lot of this money leaving bonds is heading into stock markets. But this money could also remain on the sidelines as cash, or since stocks and bonds appear bubbly, perhaps this money could be flowing into commodities which still remain quite cheap in comparison…or perhaps even cryptocurrency?
If you don’t want to think too much about the mechanics of the bond and stock market, it is sufficient to know that when the 10 year yield is rising, the stock markets have a very good probability of rising.
Now I said something about a worrying aspect. That worrying aspect is an uncontrollable sell off in bond prices which causes the 10 year yield to spike. This would be a sign of a potential stock market sell off because it would mean that central banks are having a hard time BUYING bonds to suppress interest rates. It would mean they are losing control of the system, or on the other hand, are choosing to allow this bond sell off to happen. Since everything in the US such as loans and mortgages are based on the 10 year yield, a spike would put upward pressure on interest rates.
The uncontrollable aspect could be difficult to ascertain, but looking at the 10 year yield chart, technically we have had a break out, and it appears we are heading to 1.40-1.50%. By the way, the 30 year yield (ticker symbol TYX) is back above 2%.
So this now leads to the second chart to watch for to gauge whether a market crash is going to occur: The US Dollar.
The Dollar has been dying. Not much of a surprise to us who know a currency war is occurring, and that all central banks want a weaker currency. The more juicier aspect of this is how the European Central Bank, the Bank of Canada, the Reserve Bank of Australia etc are going to respond. With a weaker US Dollar, other currencies are appreciating (and commodity linked currencies like the CAD are getting a boost from rising Oil). Not something those central banks want especially if they are trying to boost inflation and boost exports.
But the fact is that the US Dollar is still the reserve currency, and investors turn to it when they get freaked out. A lot has been said about Brent Johnson’s Dollar Milkshake Theory, and if it has been invalidated due to this US Dollar drop. I would not count it out just yet.
If we see the US Dollar rise, it is generally negative for US stocks. There is the risk aspect, but also the inflation aspect. With a weaker US Dollar, it means it takes more weaker Dollars to buy something, including US stocks. When we see the US Dollar dropping, and the 10 year yield rising in a stable fashion, this is positive for the Stock Markets.
Here is the worrying aspect: If we see the 10 year yield continue to rise AND we see the US Dollar rising at the same time…then it is time to be cautious.
It would mean that money is leaving bonds, and is heading into cash, or the reserve currency. It could mean that investors are worried about something brewing behind the scenes.
So is a Stock Market Crash incoming? With what the Federal Reserve is doing, and will continue to do, it does not appear as if a crash is coming just yet. But what we are seeing on the 10 year yield is worth keeping an eye on. Watch for how the 10 year yield rises. Is it stable? Or does it rise in an uncontrollable pace ie: large daily green candles. And do not forget about that US Dollar chart.