With the US stock market hitting new highs again and again and extending the length of the bull market to new records every day, it seems Debbie Downer-ish to say so.
But the number and intensity of warnings of an impending crash –an obvious but neglected gray rhino risk– have been increasing, and the conversation has shifted from “if” to “when” and “how bad”?
Ray Dalio, the legendary founder of Bridgewater has warned that we’re “in the seventh inning” of this economic cycle –though by that he meant that we have two years yet to go, which seems like an eternity. His new book, A Template for Understanding Big Debt Crises, warns that the next crisis will threaten both capitalism and democracy. Dalio warns that the US faces a potential nightmare scenario of unfunded liabilities and a need to borrow so much more that could put at risk the dollar’s status as a global reserve currency.
David Tice –known, to be sure, for his bearish bent, as the founder of the Prudent Bear Fund—told CNBC that “we’re getting closer to a meltdown scenario” that could bring stocks down by between 30 percent and 60 percent.
Jesse Colombo, an analyst who focuses on financial bubbles, recently analyzed possible timing of the end of the bull market and start of recession – though he doesn’t see the market bubble popping for another year. JPMorgan similarly is predicting a fall in 2020, though their analysis downplays the potential magnitude.
But any number of risk factors could create a domino effect that brings the market down sooner. George F. Will has written about the giant sucking sound of a debt spiral that problems in Turkey and other emerging markets could trigger. The inevitable hit to global growth created by Trump’s trade wars has many investors worried, as lower growth will make it harder to service the debt accumulated over the last decade.
Former US Treasury Secretary Lawrence Summers –driving home the warnings of several senior Fed officials— recently called for higher capital requirements for banks to offset asset bubbles created by extremely loose monetary policy since 2008. The worst case scenario in recent US bank stress tests envisioned 10% unemployment and a 65% drop in the stock market.
A new Congressional Budget Office report on the ballooning deficit underscores his warning.
But by looking at US markets, you’d be hard pressed to say that these warnings have had much effect. To the contrary, margin interest –an indicator of how much people are borrowing to speculate in stocks, which they will be forced to sell as prices fall- is dangerously high. The latest data, show $652.4 billion at the end of August, down a hair from a year ago –but well over double the comparable amount in 2010.
The title of a recent Seeking Alpha analysis by The Heisenberg Report, reflecting on the Turkey and broader emerging markets meltdowns, says it all: “Everybody Knew This Was Coming.” The article quotes a recent report from SocGen analyst Albert Edwards with an explanation of why markets work themselves into frenzies: “Almost nobody is interested in heeding the pessimists and positioning of the inevitable financial market blow-up when eventually excessively loose monetary policy is belatedly tightened. Investors, drunk on the elixir of free money, think the good times will roll on forever. And even if they are cautious, a few quarters of underperformance usually invites either capitulation or being fired.”
His point is well taken: anyone who sat out the market over the past year would have missed out on a lot of gains. You don’t have to sit it out entirely to be more sensible in face of an obvious danger. But you also don’t have to pile on more and more risk, as investors have been doing. Staying in the market until the inevitable fall is one thing; piling on debt to do so is something else entirely.