Sunday, August 09, 2009

Why A Stock Market Sell-Off Is Imminent

I have frequently disagreed with Mike "Mish" Shedlock in the past, but I agree with him in his assessment that stock prices are bound to fall soon.

Because unknown factors can appear and influence events, one can never be sure of what will happen in the future. But we can say what is likely to happen and what is not likely to happen given available information. And right now, all available evidence suggests that a big sell-off is underway.

What evidence am I referring too?

Beginning with fundamental analysis, we can note that compared to a year ago, earnings are down 30% while stock prices are down only 20%. Meaning that stocks have become approximately 15% more expensive than a year ago. If stocks had been undervalued a year ago that may not have been so bad, but the fact is that stocks were more expensive than the historical average already last year, and are even more expensive now.

While most companies did do "better than expected", that only reflected that "expectations" had been discretely and conveniently lowered just before the releases.

As is noted in this column, stocks are now more expensive than the historical average, particularly relative to the actual earnings during the latest year, but also relative to the 10-year average.


Bulls would presumably respond by pointing to how interest rates are lower than normal. That is true, but on the other hand I would argue that growth prospects are more dismal than normal.

Continuing then with technical analysis, we can see that stocks are now more over-bought than at anytime before the latest 8 years.

If we continue with an analysis of the monetary situation, we can see that the rapid money supply growth that started in September 2008 after several months of stagnant money supply, again turned stagnant after March. MZM has since mid-March grown at about only 4% at an annual rate. With bank credit continuing to decline, it is difficult to see any acceleration in money supply growth. Even so, this indicator is the most bullish one, indicating stable stock prices assuming all else is equal. But as this indicator isn't everything, and the other indicator clearly indicating an imminent sell-off, the overall assessment must be that a stock market sell-off will come soon.

3 Comments:

Blogger Celal Birader said...

I think it could go as high as 1050-1130 on the S&P500 before the sell-off comes probably sometime in September or October at the latest, I would imagine.

12:15 PM  
Blogger Blurry said...

Stefan,

What do you make of this article (c.f. assertions by UBS economist Paul Donovan, as published in the Financial Times)?

http://futronomics.blogspot.com/2009/08/midweek-thougts.html

4:37 AM  
Blogger stefankarlsson said...

Blurry, it was some time before I last reminded people of this so I'll let this pass this time, but questions unrelated to the topic of new posts should be posted here.

As for the key argument, that governments can't inflate away their debts because higher inflationary expectations will raise nominal interest rates, that overlooks two key factors.

First of all, governments may not need private bond investors if the central bank directly monetizes debt.

And secondly, under a system of fluctuating fiat exchange rates, artificial lowering by the central bank of real interest rates will lower the real exchange rates. That will create the expectation among many investors that the currency will appreciate (rise) in value in the future, compensating them for lower real interest rates in terms of domestic purchasing power.

9:54 PM  

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