Is a Stock Market Crash Coming in 2018?
The economic expansion that helped propel stocks to record levels is about to celebrate its 10th anniversary. While not an exact science, the cyclical nature of the economy predicts a downturn approximately every 10 years. The last one, in 2008, led to the Great Recession and wiped stocks out. Investors need to keep this in mind as we enter 2018.
Up until recently, stocks benefit from the U.S. Federal Reserve and its easy money policy, Quantitative Easing. Years of artificially low interest rates sent investors seeking strong returns for the retirement portfolios. Banks were providing next to nothing; the only place to turn was the stock market.
Against a backdrop of weak economic data, weak revenue growth, and increasing losses, stocks continued to climb steadily higher. Investors didn’t care about things like fundamentals, instead, they followed technicals. And against all odds, it’s worked for investors. Over the last 10 years, the S&P 500 has advanced 280%, the Dow Jones Industrial Average is up almost 250%, and the Nasdaq has climbed an eye watering 415%. Even the commodity heavy TSX is up 110%.
Stocks continue to climb into record territory because they’re actually starting to report solid earnings. Or put another way, stocks are building on gains that, for years, came from investor euphoria and economic stimulus—not strong results.
How overvalued are stocks? According to the Case Shiller cyclically adjusted price-to-earnings ratio (CAPE), which helped Robert Shiller win the Nobel Prize for Economics in 2013, stocks are overvalued by 93%. The ratio currently stands at 30.93, the long term average is 16. It has only been higher for longer twice; in September 1929 it was at 32.56 and in December 1999 it hit a peak of 44.20. It didn’t end well in either scenario.
Not surprisingly, a number of contrarian investors are predicting a bear market and stock market correction. Most recently, Marc Faber, the publisher of The Gloom, Boom & Doom Report, predicts that U.S. stocks will correct by as much as 30% to 40%.
In a recent interview, the man better known as Dr. Doom said, “You don’t see it. I don’t see it and nobody sees it. That’s why people continue buying stocks. Yet something will happen one day.”
Faber said that any number of small events could trigger a stock market crash. Stocks could plunge from a credit event, disclose of major fraud, or because interest rates go up.
“In 2009 when stocks bottomed out, I can tell you that not many people saw why stocks would go up,” Faber said. “Now it’s the opposite. The sky is clear. Corporate profits have been expanding — they’re good. Interest rates are low, but valuations are very high.”
Not every analyst thinks the Case Shiller PE Ratio can accurately predict a bear market or stock market crash. But even some conservative analysts are starting to pay attention. Banking giant Morgan Stanley (NYSE/MS) currently sees the real possibility of a bear market. One chief strategy expects the S&P 500 to climb five or six percent by the first part of 2018 and then forecasts a steep 20% decline.
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- Landsman, Stephanie. “The party will end when you least expect it — what Marc ‘Dr. Doom’ Faber says could trigger the next crash,” cnbc.com, September 20, 2017; https://www.cnbc.com/2017/09/20/heres-what-marc-dr-doom-faber-says-could-trigger-the-next-crash.html.
- Domm, Patti. “Morgan Stanley strategist says bear market could start next year after a surge higher,” cnbc.com, September 27, 2017; https://www.cnbc.com/2017/09/27/morgan-stanley-strategist-says-bear-market-could-start-next-year.html.
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