Caution! A Stock Market Warning.

I have said that I expect a severe economic recession to kick in by the end of 2017. I still believe this. I’ll concede that it may be in 2018. Either way: soon. Read my thoughts on this here and here.

Recessions are problematic. You probably don’t need me to tell you that. Employers lose revenue. Employees lose jobs. Producers lose buyers. So on, so forth. It is the collective train wreck.

A major recession is often preceded by a stock market downturn. Not always a crash, but a serious bear market. Nowadays, stocks are at all time highs. Are we in a new era? Have stocks reached the permanently high plateau so famously proclaimed by monetarist godfather Irving Fisher mere months before the 1929 Stock Market crash? Probably not.

Don’t take my word for it. Take it from a Nobel Prize winner:

The last time Robert Shiller heard stock-market investors talk like this in 2000, it didn’t end well for the bulls.

Back then, the Nobel Prize-winning economist says, traders were captivated by a “new era story” of technological transformation: The Internet had re-defined American business and made traditional gauges of equity-market value obsolete. Today, the game changer everyone’s buzzing about is political: Donald Trump and his bold plans to slash regulations, cut taxes and turbocharge economic growth with a trillion-dollar infrastructure boom.

“They’re both revolutionary eras,” says Shiller, who’s famous for his warnings about the dot-com mania and housing-market excesses that led to the global financial crisis. “This time a ‘Great Leader’ has appeared. The idea is, everything is different.”

For Shiller, the power of a new-era narrative helps answer one of the most hotly debated questions on Wall Street as stocks set one high after another this year: Why are traders so fixated on the upsides of a Trump presidency when the downside risks seem just as big? For all his pro-business promises, the former reality TV star’s confrontational foreign policy and haphazard management style have bred uncertainty — the one thing investors are supposed to hate most. . . .

Shiller says when markets are as buoyant as they are now, resisting the urge to pile in is hard regardless of what else might be happening in society.

Everybody gets the money fever. It’s always about the next dollar, regardless of what indicators might be on the horizon.

“I was tempted to do it, too,” he says. “Trump keeps talking about a new spirit for America and so you could (A) believe that or (B) you could believe that other investors believe that.”

On whether stocks are nearing a top, Shiller can’t say with any certainty. He’s loathe to make short-term forecasts.

Despite the well-timed publication of his book “Irrational Exuberance” just as the dot-com bubble peaked in early 2000, the Yale University economist had warned (with caveats) that shares might be overvalued as early as 1996. Investors who bought and held an S&P 500 fund in the middle of that year made about 8 percent annually over the next decade, while those who invested at the start of 2000 lost money. The S&P 500 sank 49 percent from its high in March 2000 through a bottom in October 2002. The index has gained 6 percent this year, with futures slipping 0.1 percent before the open of U.S. exchanges on Tuesday.

What Shiller will say now is that he’s refrained from adding to his own U.S. stock positions, emphasizing overseas markets instead. One factor that makes him cautious on American shares is the S&P 500’s cyclically-adjusted price-earnings ratio: While the metric is still about 30 percent below its high in 2000, it shows stocks are almost as expensive now as they were on the eve of the 1929 crash.

“The market is way over-priced,” he says. “It’s not as intellectual as people would think, or as economists would have you believe.”

Margin debt is through the roof: a new record at $513 billion. Investors are highly leveraged:


NYSE margin debt indicators should not be used by analysts to predict a recession. Margin debt is small compared to the total value of NYSE-listed stocks: roughly $20 trillion. But history suggests that NYSE margin debt will be near record highs when a stock market crash occurs. I will put it this way: because I expect a market crash within the year, I am not surprised to see margin debt at such levels.

The bulk of the middle class is not in stocks. A stock market crash more directly impacts the upper and upper-middle class, who do actively invest in stocks. Recently, they have been investing a heck of a lot more in stocks:

Households now have more than $20 trillion of equity holdings, representing 38.5% of their total financial assets, which includes houses and other tangible properties.

Those levels are now close to the peak seen in 2007, though still below the levels during the late 1990s dot-com bubble, when nearly half of U.S. household wealth was in stocks, said Ned Davis, founder and senior investment strategist at Ned Davis Research Group, in a note.

Excluding property and other hard assets, stocks represent 53.5% of holdings for U.S. households, above the 44.8% norm since 1952, according to Davis. Meanwhile, cash and bond holdings have decreased, with cash at 24.7%, compared with an average of 32.2%, and bonds presently at 21.8% versus an average of 23% over the past 65 years.

The emergence of flows to equity exchange-traded funds, followed by a rally since the Nov. 8 presidential election, may be one reason behind the elevated levels of stock ownership. According to Investment Company Institute, a trade association of U.S. investment companies, an estimated $45.67 billion flowed into mutual funds and ETFs investing in U.S. stocks in November and December, following President Donald Trump’s victory, which resulted in a months-long stock-market rally.

Many of these investors are older folks: 60 and up. Their retirement income relies on stocks. If they lose their money in a market crash, this is going to smash their spirit into bits. It will literally destroy their dreams of an upper-middle class retirement and force them into a “living on Social Security” retirement.

Corporate buybacks have kept major stocks afloat for the past three years. But this does not lead to increased productivity. This produces no new revenue streams. When a recession hits, this practice will end. Corporations are going to be desperate for cash. Buybacks will cease. This will utterly smash a large portion of investors.

The super-rich will be able to take it, even though they stand to lose the most money. Warren Buffet lost a staggering $10 billion by the end of 2008. But his net worth was near $60 billion. Ultimately not a big deal. The upper and upper-middle class will not be able to take it so stalwartly. They stand to lose a majority share of their wealth in stocks.


Retirees who are betting the farm on stocks face huge risks. This next stock market crash will break some of them. Corporations are going to scramble for money. Expect unemployment to rise. Innovation will slow down. This is the way of things in a recession.

I’m not predicting a zombie apocalypse. People will not starve in the streets. But those unprepared will likely take a lifestyle hit. People in large homes will move into smaller homes. People who can’t afford their smaller homes will move in with family. Lifestyles will have to move in line with economic reality until a recovery, which could take a few years.

Trump is going to have to go on the defensive politically. He won’t get most of his agenda through. No tax cuts. His healthcare alternative bill was not passed. His promises to deport millions of illegals will fall apart. He’s going to have a hard time holding on to the optimistic sentiments of the people who voted for him.

The most important thing you can do in a recession is this: keep your job. You would do well now to prove yourself as one of the top 20% of employees at your workplace in terms of value and performance.




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