Crash Alert

TIVOLI, New York – We hadn’t even had our morning coffee on Friday when we got an alarming message from Stephen Jones, who does stock market research for us.

Stephen – a former equity analyst at Value Line – has been working on a proprietary indicator. The aim is to give us a better understanding of the expected returns on stocks, given today’s rich valuations.

We’ve already reported on his long-term forecast: He expects the U.S. stock market to fall, on average, by 10% a year for the next decade.

So, if the Dow is somewhere close to 6,030 points in August of 2025 (the result of a compound loss of 10% a year over that period) Stephen will be proven right.

But what about now? What can we expect in the short term?

We don’t know. But on Friday, Stephen sent us a “Crash Alert” – his first ever.

A “Large and Dramatic Downturn”

Writes Stephen:

Short-term market timing is typically best used for entering and exiting positions or making modest adjustments to the size of the equity position in a portfolio. There are very few times when one should consider making more dramatic moves.

Now is one of those times. Not that there is any guarantee that a market downturn is will occur; however, the evidence suggests that a very large and dramatic downturn is imminent for the equity markets.

By “large,” we mean a decline in excess of 50%. By “dramatic,” we mean a period of less than three years. Examples include the 21-month decline from January 1973 to September 1974… the 25-month tumble from August 2000 to March 2009… and the 17-month fall from October 2007 to March 2009.

“Imminent” is the most difficult part of this forecast; however… the decline appears likely to start within the next three months.

Back-tested to 1952, Stephen’s indicator has been at this level only 7% of the time. And after that happened, investors took big losses.

Cronies on the Run

We take no pleasure in a stock market rout. Not personally anyway. We make our living by offering economic commentary and financial advice. This will be bad for business.

Still, we can enjoy it vicariously. And okay… maybe a little dark smile crosses our lips. The kind the Germans have a word for –Schadenfreude (which literally translates as “harm-joy”).

The cronies are on the run. Mr. Market, Main Street, and the real economy are finally striking back.

The trillions of dollars of stock buybacks at or near record-high prices are beginning to look like what they were all along: looting of corporate treasuries by the insiders.

All that blather about central banks stimulating a recovery via monetary interventions is beginning to sound like the B.S. it always was.

Plus, at the Diary we have a deep and abiding amor fati. We like it when what should happen actually does. It settles our nerves. Pope Francis is at the Vatican. Janet Yellen sits in the comfiest chair at the Fed. And stocks are falling. All is right with the universe.

But Friday’s market break has made everybody jittery… running scared… sweating. MSN Money on Friday afternoon, after the Dow registered a 531-point drop:

The Dow Jones industrial average fell more than 500 points, into correction territory for the first time since 2011 as all blue chips declined. In the last five years, the index has only had four instances with closing losses of more than 400 points.

The Nasdaq Composite lost more than 3%, also closing in correction territory and joining the other major averages in negative territory for the year.

Apple lost about 6%, into bear market territory, and the iShares Nasdaq Biotechnology ETF (IBB) plunged 2.5%.

‘Right now there is a feeling of fear in the marketplace and all news is interpreted negatively and it’s interpreted indiscriminately,’ said Tom Digenan, head of U.S. equities at UBS Global Asset Management.

Not so! Should You “Buy the Dip”?

As expected, Wall Street came out on the weekend explaining why you should “buy the dip.”

“Stock sell-off looks overblown to three Wall Street strategists,” assured a headline on Bloomberg on Sunday.

“Biggest U.S. Stocks Look Like Global Havens to Bank of America,” said another.

MSN Money explains why there is nothing to worry about…

Is there more selling to come? No one knows, but corrections are natural in a bull market, a pause in the market’s march higher, and this one is long overdue. They usually come about once every 18 months. The last one was four years ago.

Get it?

A pause in the market’s march higher.

Financial adviser Suze Orman – about the smartest financial expert on the planet (next to Janet Yellen, of course) – was quick to go to the heart of the matter.

Via Twitter, Orman reminds us that the fix is in:

I am taking this year off, but it is hard to sit silently and watch these markets. Fed Chair Yellen, help us out.

Oh, Saint Janet! Patron saint of bubbles. Touch us. Heal us. Give us more cheap credit. Give us more EZ money.

Have faith, dear reader. Have faith. Saint Janet will not forsake us.


Bill Bonner
for The Daily Reckoning

Originally posted at Bill Bonner’s Diary, right here.

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