In Part 1 of this series on how to check the health of a late-stage bull market, I detailed the first six of 16 indicators I use to see if a crash is on the horizon.
Indicators That Help Predict a Coming Market Crash
We were up to three and one-half red flags out of the first six we covered. Without further adieu…
7. Cycle Theories: Market, Seasonal, and Business.
Where we are in the Market Cycle:
Our current bull market in stocks started with the classic Letter V Bottom early in 2009 and it has raged on with only a few breathers since. Our bull has grown old. Really old. It has passed stud status and is ready for the pasture.
In fact, it just turned 100 months on July 9th.
Why is this significant? It is now the second oldest bull market in history, behind only the 113 month run of 1990-2000. The 269% trough to peak increase (from the ominous low of 666.79) also became the second-largest bull by percentage as gauged by the S&P 500.
Just as humans, bulls die when they get too old.
Where we are in the Seasonal Market Cycle:
Most traders are familiar with the expression, “sell in May and go away.” Well, there is a lot of truth in that old saw.
Since the 1950s, the Dow Jones Industrial Average has risen over 7% between November and April. May through October is essentially flat.
Moving the time frame back to the 1920s, the stock market performs worst in the late summer and early fall, with September being the only negative month in the calendar year, with October being second worst.
However in the last 20 years, August has become the worst month with September being no great shakes.
Although seasonality has fluctuated and shifted to seeming unreliability, it is worth noting that almost all the truly nasty crashes – amongst them: Black Tuesday in October 1929, Black Monday in October 1987, and the Great Recession Crash in September 2008 – have occurred in the late summer, early fall portion of the calendar.
Why is this? Honestly, who the hell knows for sure. Most likely it is a self-fulfilling prophecy that spooks investors. The stock market is, after all, one giant psychological petri dish with only two known elements growing on it: greed and fear.
No matter the reason, Crash Season is heading our way.
Where we are in the Business Cycle:
The business cycle has grown longer than historical norms for some time now. Many would say it is because the Federal Reserve has gotten better at predictions. This is hogwash. The business cycle has increased in length only because the Fed has pumped so much zero interest rate adrenaline to an increasingly inured patient and because Uncle Sam has gotten much more devious with his lies.
Remember, t’s not a recession if you tweak enough numbers to give the impression of growth and full employment.
But, whatever. We’ll roll with their phony data. Even so, this is again the second-longest business cycle in history. it will end soon.
What is an absolute fact, is that the business cycle lags the market cycle by 6 months to a year. As goes Wall Street, so goes Main Street soon after. If there is a crash this fall, there will be a recession in 2018.
Cycle Theory Verdict: Red Flag four and one-half out of seven.
8. Political Factors
This one is almost entirely devoted to whether President Trump presses his nationalist agenda and if legislation passes Congress.
Wall Street has priced in their own dominance of the United States economy. If Trump manages to push through reforms that radically alter the status quo, Big Money will throw a tantrum; think of things like killing NAFTA, ending Silicon Valley’s reliance on foreign labor, and other similar reforms that hurt the globalist bottom line.
This extortion really has to stop, even if it costs us a bull market that is dying anyway. He has to press forward for the good of the country in the long run.
Verdict: Trump seems to be trying to install his America First vision, but weak Congressional Republicans are dragging their feet on his agenda, and the Leftist Party would vote against a Trump resolution that said the sky was blue. Gridlock is almost assured. The markets love that. No red flag as of yet. We hold at 4.5 out of 8 on the Crash Index.
9. Price to Earnings (P/E) Ratios
The very astute Robert Shiller, who nailed the scope of the housing bubble, has developed a metric called Cyclically Adjusted Price to Earnings (CAPE). This CAPE ratio sits at such a level that it has only been exceeded by the era of the NASDAQ tech bubble.
What ranks third and fourth on the highest levels of CAPE?
1929 and 2007.
Verdict: Red Flag number 5.5.
10. Margin Levels
Margin debt has a high correlation to stock market meltdowns.
It is indicative of manias, for if we are in a “paradigm shift”, we think, then surely the good times will keep rolling. Let’s borrow money to buy more stocks on leverage! This is one of the most consistent indicators over the decades.
Think of margin levels as the fateful dessert at a luxurious meal just before you have a heart attack. Folks in 1929 gorged on so much margin debt – at the rate of over 8% of U.S. GDP and rules that allowed investors to borrow 9 dollars for every dollar in equity – that it ended up being the major cause of the market collapse and subsequent Great Depression.
Where do we stand today?
The New York Stock Exchange’s measure of margin debt as a percentage of GDP as of May 2017 is at extremes once again. The following chart is sourced from Williams Market Analytics.
Look at the spikes; 2000, 2008, and the August 2015 mini-meltdown. We’re right back at those levels.
Red Flag 6.5.
11. Initial Public Offerings (IPOs)
Another sign of potential trouble is when private companies rush to get listed on the exchanges late in a bull market. They do so (with prodding from their Wall Street underwriters) to avoid missing out on all the fun.
As the tech bubble was close to bursting, IPOs were a daily event. Literally. Almost 500 companies went public in 1999. Shares would go bonkers almost immediately due to rabid demand from investors. Even dogs like Commerce One would have percentage gains in the triple and quadruple digits.
Insiders want those shares out so they can dump their stock options into the frenzy and become multimillionaires in mere days. The trendier and the hotter the sector, the more danger of it not ending well for the stock market.
1987 was another banner year for IPOs. 2007 was strong as well, but not to the same extent. You can find IPO data here.
How is 2017 looking?
Rather middle of the road. 2016 was a dull year for IPOs, but the pace is picking up in 2017. It is not, however, out of line with a normal year.
No red flags here. We stand at six and one-half out of eleven.
12. The Yield Curve
Bond traders in general are a much sharper bunch than equity traders. The history of the inverted yield curve proves this point as it is a well-known forerunner of recessions.
The curve will gradually flatten and then eventually invert when bond traders (almost always large institutional holders) sense trouble coming in the economy.
How is it looking in July of 2017? Just fine, but it has been flattening if ever so slightly. Nothing to worry about so far, but keep an eye on it. No red flag on this one. We hold at six and one-half out of twelve on the Dystopia USA Crash Index.
P.S. – In the next day or two, I will post the last four crash indicators and finish with a summation and outlook based off these signals. So, stay tuned for Part 3.
P.P.S. – As I stated in Part 1, this is not financial advice. It is for educational and informational purposes only. Every investor must do their own due diligence.
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