Congratulations to the traders who rode this market rally up from what Larry Kudlow refers to as “the mother of all bottoms”. The rally appears to be in full bloom and stockowners are happy. Any one suggesting that a crash is possible would be dismissed as a nut case. Yet that’s exactly what I am going to suggest in this article. So you may want to dismiss me now and move to the technical analysis section below.
Once again, nobody cares that stock investing consists of owning shares in businesses. No one cares that any purchase of a business should be viewed as an investment, and should provide earnings, growth prospects, and dividends to justify the purchase. Today’s market is speculative and prices are being determined purely by happy feelings and emotions. There is a gigantic discrepancy between intrinsic values of most companies’ stocks and their stock market prices. In many companies, wealth continues to be transferred from its shareholders to its management via stock options and share buybacks of stock market-overpriced businesses. Shareholders don’t have a clue or even care. At the margin where prices are being determined, shareholders are not shareholders at all.
I believed that throughout this rally, the stock market has had the potential to crash. It hasn’t yet, but when the market does crash, it may crash in a devastating manner. You should consider the question of, “If the market goes down, HOW would it go down?” The questions that are explored in the mainstream financial media, TV, and Internet, deal with IF and WHEN the stock market can go down. They rarely explore the question of, HOW it may go down? How far, how fast, how devastating? The dumbed-down public does not consider this question because in their collective minds, we have already seen the answers to these questions in the stock market from March of 2000 to October of 2002. The answers in their minds are VERY far, PRETTY fast, and by in large, NOT TOO devastating. By in large, they think we are now in a new bull market.
But the facts are that the market is valued similarly to October 1929, Wall Street chicanery is at peak levels, consumer debt is at record levels, corporate debt is at relatively high levels, the dollar is plunging, and the trade deficit is rising along with the Federal budget deficit. The Federal budget deficit doesn’t scare any one any more. Why? The public remembers how it was extinguished in the late ‘90s. They are thinking, “No problem. If it was paid off before, we can do it again”. What very few people think about is the fact that the elimination of the deficit was largely a result of capital gains taxes that the government enjoyed from the late 90s stock market bubble. They don’t see this as an, (aha’ hem), “one-time event”. The current Federal budget deficit can only be extinguished again if we can manage to create a bigger stock market bubble than before. My money says it can’t. In the absence of another stock market bubble we will have to pay the money back. This will have to be achieved through the sweat equity of our children and us or from inflation, which will dilute (reduce) our wealth.
Every casual stock market participant is now bullish. Everyone KNOWS that the stock market is going up. Greenspan will continue to keep any crash from happening. Corporate management will continue with the positive press releases that “beat-by-a-penny”, and are “better-than-expected”.
Overvaluation, chicanery, and everybody thinking alike suggest to me that all the ingredients for a stock market crash are in place. The only thing missing is the catalyst, and there are a variety of potential ones on the horizon. The risk (of a crash) greatly outweighs the marginal gains that can be made at this point.
What most people are thinking is typified in the Charles Schwab commercials:
“The market has changed and this time we’re going to change with it.”
I think Schwab’s use of “change” is code language for knowing that the rally will end and Schwab investors should know when to bale out when they see market weakness. There is a serious risk that this will not be possible, though. Almost every one is thinking the same thing at the same time. When the time to exit arrives, the hatch may be too small to let the public out in time. There is every reason to believe that a crash may ensue.
There are additional reasons for a crash such as an overactive public. Momentum investing has never been more popular with the public than it is now. Chat boards are once again ablaze with the number of postings from the “lunatic fringe”. Momentum-based IBD has raise
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