Why Another 50% Correction Is Possible - Monday, Dec. 10

All of sudden….volatility.

Well, that is what it seems like anyway after several years of a steady grind higher in the markets. However, despite the pickup in volatility, the breaks of previous bullish trends, and a reversal in Central Bank policy, it is still widely believed that bear markets have become a relic of the past.

Now, I am not talking about a 20% correction type bear market. I am talking about a devastating, blood-letting, retirement crushing, “I am never investing again,” type decline of 40%, 50%, or more.

I know. I know.

It’s the “doom-and-gloom” speech to try to scare investors into hiding in cash.

But that is NOT the point of this missive.

While we have been carrying a much higher weighting in cash over the last several months, we also still have a healthy dose of equity related investments.

Why? Because the longer-term trends still remain bullish as shown below. (Note: The market did break the bullish trend with a near 20% correction in 2016, but was bailed out by massive interventions from the ECB, BOE, and BOJ.)

Now, you will note that I keep saying a 20% “correction.” Of course, Wall Street classifies a bear market as a decline of 20% or more. However, as I noted recently:

“During a bull market, prices trade above the long-term moving average. However, when the trend changes to a bear market prices trade below that moving average. This is shown in the chart below which compares the market to the 75-week moving average. During ‘bullish trends’ the market tends to trade above the long-term moving average and below it during ‘bearish trends.’”

In other words, at least for me, it is the overall TREND of the market which determines a bull or bear market. Currently, that trend is still rising. But such will not always be the case, and we may be in the process of the “trend change” now.

The Collision Of Risks

Of course, after a decade of Central Bank interventions, it has become a commonly held belief the Fed will quickly jump in to forestall a market decline at every turn. While such may have indeed been the case previously, the problem for the Fed is their ability to “bail out” markets in the event of a “credit related” crisis. Take a look at the chart below.

In 2008, when the Fed launched into their “accommodative policy” emergency strategy to bail out the financial markets, the Fed’s balance sheet was only about $915 Billion. The Fed Funds rate was at 4.2%.

If the market fell into a recession tomorrow, the Fed would be starting with roughly a $4 Trillion dollar balance sheet with interest rates 2% lower than they were in 2009. In other words, the ability of the Fed to “bail out” the markets today, is much more limited than it was in 2008.

But it isn’t just the issue of the Fed’s toolbox. It is the combination of other issues which have all coalesced which present the biggest risk to a substantial decline in the markets.

Valuations

One of the most important issues overhanging the market is simply that of valuations. As Goldman Sachs pointed out recently, the market is pushing the 89% percentile or higher in 6 out of 7 valuation metrics.

1 2 3 4
View single page >> |

Disclosure: The information contained in this article should not be construed as financial or investment advice on any subject matter. Real Investment Advice is expressly disclaims all liability ...

more
How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.