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The market correction during August was shocking only in how quickly it evolved. Market corrections of this magnitude normally occur in 8 or 9 years out of 10. We have not, however seen anything like the sudden the 1000 point drop in the Dow since Black Monday in 1987. I believe this correction ushers in a new bear market. A bear market was the inevitable result of valuations inflated to extreme levels that have persisted for the last couple of years. The question was never “if” the stock market would implode upon itself, only when. Overvaluation can persist for a ridiculously long time, but three key market divergences have emerged during the last 12 months indicating the day of reckoning was close:
- Long term T-Bond yields have remained low, but yields on shorter maturities have risen significantly.
- Corporations with top credit ratings have continued to enjoy low borrowing costs; however the price of credit to lower rated borrowers has risen sharply.
- Finally, despite a continued rise in stock indices to record highs (at least until a few months ago) the prices of most US stocks were declining. That decline brought the average stock down more than 20% (even before the 1000 point plunge). The widespread failure of stock prices has been masked from the investing public by market indices that give companies with bigger market capitalizations more weight. Since the market cap of the 5 largest stocks represent about half the S&P 500, the rise of a few mega stocks (like Google, Netflix and Amazon) temporarily offset the ongoing deterioration in the rest of the market.
A handful of us with a serious grasp of second grade math have fought the insanity of the mania in the stock (and bond) markets. We choose to look foolish by refusing to participate in the mania rather than expose ourselves and our clients to the kind of devastating market declines the US markets suffered twice in the prior decade. The abnormal stability of stock prices during the past few years is over. Black holes like we just experienced in August will recur. Each plunge will create “oversold” conditions followed by dramatic rallies that temporarily recover half to two thirds of that loss. The rallies will be supported by data (accurately) indicating that the US economy continues to grow, albeit rather slowly. Those rallies will provide false hope that each decline is yet another buying opportunity, but the descent of US Stock prices is only beginning.
2.18.15 - Annual Forecast
12.17.14 - The New Paradigm for Global Markets
10.9.14 - Markets Rolling Over
5.30.14 - Bank Lending and Economic Growth
2.20.14 - February Flash Update
1.15.14 - 2014 Annual Forecast
12.10.13 - Bursting of the Bond Bubble
11.13.13 - A New Top for Stocks?
7.23.13 - Bursting of the Bond Bubble
5.9.13 - The TINA Hypothesis
4.15.13 - The Bernanke Illusion
3.15.13 - US Economic Outlook
2.1.13 - 2013 Annual Forecast
12.10.12 - Tax Reform: A First Step
9.17.12 - QE3
5.1.12 - All the Good Ones Are Taken
3.12.12 - March Flash Update
2.23.12 - February Flash Update