The Case for a Crash

And for staying in cash until 2015
Tuesday, December 10, 2013, 3:24 PM

We’ve recently been treated to two mutually exclusive forecasts: that the Great Bull Market will run until 2016 or 2018, so no worries; and that markets are exhibiting bubble-like characteristics that presage another crash.

So which forecast is more likely the correct one?

Analysts of every stripe—fundamental, quantitative and technical—pump out reams of data and charts to support one forecast or another, and economists (behavioral, macro, etc.) weigh in with their prognostications as well.  All sorts of complexities are spun as a by-product of producing research that’s worth paying for, and it all becomes as clear as…mud. 

As an experiment, let’s strip away as much of the complexity as possible and look at a few charts of what many observers see as the key components of the U.S. economy and stock market.

Let’s start with a basic chart of the S&P 500 (SPX), a broad measure of U.S. stocks:

Without getting fancy, we can discern three basic phases: what we might term “the old normal,” from the late 1950s to 1982; an amazing Bull Market from 1982 to 1994 that saw the SPX more than double; and a third phase that some consider “the new normal,” a leap to the stratosphere in the 1990s, followed by sharp declines and equally sharp rises to new highs.

This third phase of extreme volatility does not look like the previous phases; that much is clear.  Is this a new form of volatile stability; i.e., are extreme bubbles and crashes now “normal”?  Or are these extremes evidence of systemic instability? About the only things we can say with confidence is that this phase is noticeably different from the previous decades and that it is characterized by repeating bubbles and crashes.

Let’s zoom in on this “new normal” from 1994 to the present. Does any pattern pop out at us?

Once again, without getting too fancy, we can’t help but notice that this phase is characterized by steeply ascending Bull markets that last around five years. These then collapse and retrace much of the previous rise within a few years.

The reasons why these Bull phases only last about five years are of course open to debate, but what is clear is that some causal factors arise at about the five-year mark that cause the market to reverse sharply.

The ensuing Bear markets have lasted between 2.5 and 1.5 years. We only have three advances and two declines to date, but the regularity of these advances and declines is noteworthy.

Next, let’s consider other potential influences on this “new normal” of wild swings up and down. Some have observed a correlation between the cycles of the sun’s activity and the stock market, and indeed, there does seem to be a close correlation—not so much with the amplitude of the market’s recent moves but with the economic tidal forces of recession and Bull/Bear sentiment.

But there is nothing here to explain why the highs and lows in the stock market have become so exaggerated in the “new normal.”

Many have attempted to correlate key dynamics in the U.S. and global economy to the stock market’s gyrations.  Let’s look at a handful that are often offered up as important to the U.S. markets: the bond market (TLT, the 20-year bond index), the Japanese yen, gold, and the U.S. dollar.

If there is some correlation between the SPX and the TLT, it isn’t very visible.

How about the Japanese yen? Once again, there is no correlation to the SPX that is obvious enough to be useful.

Some analysts see the yen and gold as tightly correlated; here is GLD, a proxy for gold:

There is a clear correlation here, but as we all know, correlation is not causation, which means that some underlying forces could be causing the yen and gold to act in a similar fashion. Alternatively, the yen is acting on gold in a causal role.

In either case, the problem with correlations is that they can end without warning.  Since neither the yen nor gold correlate with the S&P 500, neither one helps us forecast a continuing Bull or a crash.

Lastly, let’s look at the U.S. dollar (DXY).

As I have noted elsewhere, the dollar doesn’t share any meaningful correlation with the S&P 500, yen, gold, or bonds in terms of trends, highs, or lows.  Here is a longer-term view of the Dollar Index, and once again we see no useful correlation to the SPX:

Proponents of cycles (17.6 years, for example) claim a high degree of correlation with actual highs and lows, but these cycles do not exhibit the fine-grained accuracy we might hope for in terms of deciding to buy, short, or sell stocks.

Analyst Sean Corrigan has described a remarkable 33-year cycle of highs and lows in the SPX:  lows in 1949, 1982, and (forecast) 2015, and highs in 1967 and 2000, (forecast of next high, 2033). While interesting on multiple levels, these cyclical data points are rather sparse foundations for decisions on whether to sell or hold major positions in the stock market, and they do not provide a forecast of the amplitude of any high or low.  Given the extremes of the “new normal,” we would prefer a forecast, not just of time, but also of amplitude.

Though it is unsatisfyingly imprecise, the “new normal” phase strongly implies that future declines will be as dramatic as the advances and that the five-year clock is ticking on the current Bull market. Forecasting an advance that lasts years beyond this five-year pattern is equivalent to forecasting that the “new normal” phase is now ending and a new phase of much longer Bull advances is beginning.

That is a bold claim, and there is little historical data to give it much weight.  Stripped of complexity, the charts suggest that the current run will top out within the next few months and retrace most of the advance from 2009; i.e., a crash of significant amplitude.

In Part II: The Case for Cash, we analyze the indicators that help us determine the likelihood of a coming crash similar in magnitude to 2000-02 and 2008-09, and why a strategy of selling risk assets now, and holding the cash until income-producing assets “go on sale” at the trough of the next market decline, seems especially prudent at this time.

Click here to access Part II of this report (free executive summary; enrollment required for full access).

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Mark_BC's picture
Status: Gold Member (Offline)
Joined: Apr 30 2010
Posts: 429
The main difference I see

The main difference I see with this current cycle peak over previous ones is that the printing presses are now running full tilt. Even on the last major bust cycle in 2007/8, there was still a significant amount of market forces at play, whereas today there isn't any of that; it's completely manipulated.

I'll admit that I don't fully understand the mechanism of how the Fed is buying up all these various assets and putting them on its balance sheet, but I can't see any fundamental reason why the Fed couldn't start becoming the buyer of last resort for equities and ensure that a collapse never happens, just like it's doing in the bond market right now.

Those with inside information would use derivatives to amplify the gains above what inflation is and then buy real assets with the profits. Those profits would come from deflationists who bet on a collapse that never comes. This could continue exponentially for a while until inflation really starts to kick in, at which point the average person shuns money and we get hyperinflation. At that point the exponential increase in the stock market will lose relative value to the true inflation rate which will be even more exponential, and precious metals and hard assets will emerge as the only things that maintain relative value. But until that happens, the elites could make a lot of money off a stock market bubble that never bursts.

Prior instances of hyperinflation had some deflationary bouts before the final kicker through which things went exponential, "without warning".

2xminers's picture
Status: Member (Offline)
Joined: Aug 26 2008
Posts: 1
Note this solar cycle is lower than shown in the 2003 data above


The current 2014-2015 sunspot peak projection is about half of all those shown in the above chart from 2003. Our current cycle is the lowest since 1906! Also if you used an updated sunspot graph including the recession of 2009/2010 you will see this last recession happened at the sunspot cycle low.

Clearly there are trends, and cycles, but possibly the Fed has manipulated things to such a degree that the economic dip it is offset a bit from the past. Now it looks like there was a recession for the first time ( since 1932/1933) at the sunspot cycle low in 2009, maybe we will again resume having them at the peak in 2014/2015.


Thanks for the article.

redcloud's picture
Status: Bronze Member (Offline)
Joined: Mar 12 2009
Posts: 30
Mark_BC wrote: I'll admit
Mark_BC wrote:

I'll admit that I don't fully understand the mechanism of how the Fed is buying up all these various assets and putting them on its balance sheet, but I can't see any fundamental reason why the Fed couldn't start becoming the buyer of last resort for equities and ensure that a collapse never happens, just like it's doing in the bond market right now.

I completely agree.  Given that the Fed is run and controlled by former and future Wall street executives I don't see how things could go any other way.  Why kill the goose that laid the golden egg.  This game plan allows the elites to buy up all the real wealth in the country.  The timing of the unwinding is of course very hard to predict but eventually it will have to collapse.

olenzekm's picture
Status: Member (Offline)
Joined: Oct 29 2010
Posts: 6
The Rich Have Too Much Money

The main reason for the bubbles is simple. The Rich have too much money

In the old days, the Rich had only enough money to invest in productive activities, such as building plant and equipment to manufacture things that people actually used. Since Reagan and "supply side" economics, the Rich have been given huge tax breaks and other financial perks. The middle and low classes were deprived of the benefits of increased productivity, etc. So now there is a huge imbalance in our economy with way too much money on the supply side.

Now, the Rich no longer have enough productive investments to soak up their savings. So they have taken to speculating in various asset classes, the most popular of which is the stock market. Since unlike plant and equipment stocks can be easily liquidated during downturns and bought during up times, this leads to the volatility that we see.

Another way to look at it is by considering feedback loops. Finance works on a positive feedback loop. Higher prices lead to more higher demand which leads to even higher prices. Lower prices lead to even lower prices, etc. This is counter to the "real" economy where high prices lead to less demand which dampen further price increases. Positive feedback are inherently unstable, hence our current instability. Since finance now contributes about 30% of our economy compared to 10% in the past, the entire economy is unstable.

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