Sunday Musings: Looking Ahead To The Next Crash

Ulli Uncategorized 4 Comments

While I don’t agree very often with Paul Farrell, he did have some interesting thoughts in “Market Crash 2011: It will hit by Christmas.” Here are a few highlights:

Our brains never learned 2008’s lessons, will fail again in 2011

Remember, we can’t help it. Our brains are defective, biased, manipulated by unseen forces 93% of the time. So blame all the lies, lying and liars on our brain wiring. A perfect excuse. Sure, political dogma and insatiable greed factor into our bizarre mental equations. But your brain is as susceptible to the “great con” as Ben Bernanke, Henry Paulson, Bernie Madoff.

Go back a few years: The subprime credit meltdown was widely predicted years in advance. For example, back in 2007, the IMF’s Chief Economist, Raghuram Rajan, “delivered a stark warning to the world’s top bankers: Financial markets were headed for doom. They laughed it off,” said the Toronto Star. Both Alan Greenspan and Larry Summers were there.

In April 2007, Jeremy Grantham, whose firm manages $107 billion, also warned investors: “The First Truly Global Bubble: From Indian antiquities to modern Chinese art; from land in Panama to Mayfair; from forestry, infrastructure, and the junkiest bonds to mundane blue chips; it’s bubble time. … Everyone, everywhere is reinforcing one another. … Bursting of the bubble will be across all countries and all assets … no similar global event has occurred before.”

We knew a crash was coming, Wall Street laughed.

Warning: Cyclical bull ends in 2011, new cyclical bear roars back

At the beginning of 2011 USA Today reported a contrarian forecast. Ned Davis Research says the S&P; 500 will make a run at the 2007 high of 1,565, but hit a “midyear peak.” Then it will crash as interest rates rise. Davis concludes: “The midyear peak could mark the end of the cyclical bull market that began in March 2009 and the start of a new cyclical bear market.”

Warning, even though your brain doesn’t want to hear it, there is a high probability a new cyclical bear market will begin this summer … and overshadow the 2012 elections.

The Journal’s also warning: “Inflation jitters spread through emerging markets, prompting China’s central bank to raise interest rate for the third time in four months amid worries that a drought threatening the country’s wheat crop will put further pressure on global food prices.”

Wake up America: With commodity prices rising rapidly, all the bizarre rationalizations Wall Street uses to keep Bernanke’s interest rates low are rapidly vaporizing. Yes, Ned Davis’ prediction of a bear will soon be a painful reality.

S&P; 500 inflated, worth just 910, get out before it tops 1,500

Grantham also sees inflation and rising interest rates killing the lies, popping the bubble and ending the rally: “As a simple rule, the market will tend to rise as long as short rates are kept low. This seems likely to be the case for eight more months and, therefore, we have to be prepared for the market to rise and to have a risky bias.”

With $107 billion at stake Grantham better be concerned. He predicted the 2008 meltdown, now sees a repeat dead ahead: “Be prepared for a strong market and continued outperformance of everything risky, but be aware that you are living on borrowed time as a bull.”

Yes, the bubble will pop this year says Grantham: “If the S&P; rises to 1,500, it would officially be the latest in the series of true bubbles. All of the famous bubbles broke, but only after short rates had started to rise.”

So keep a close watch on those two tipping points in your planning, interest rates breaking to the upside and the S&P; closing near 1,500. When inflation pushes interest rates up they’ll choke off this bull market. If you’re active, better stop chasing higher returns, especially emerging markets.

Bottom line: In what sounds like a direct shot at super-bull Jeremy Siegel, Grantham says that GMO’s research warns that “the market is worth about 910 on the S&P; 500, substantially less than current levels” just above 1,300.

Then Grantham throws his fast ball right down the middle: “The speed with which you should pull back from the market as it advances into dangerously overpriced territory this year is more of an art than a science, but by October 1 you should probably be thinking much more conservatively.”

[Emphasis added]

Jeremy Grantham has been one of the few who predicted the 2008 market massacre, so you want to pay attention to what his view of the future is.

The critical point, as he mentioned, are short term interest rates. Once they start to rise, this trend may very well reverse and another bubble will burst. I would add that his time frame could change in a hurry in the case of a major financial disruption, such as a European debt default, causing rates to rise sooner than anticipated.

Again, markets generally don’t crash overnight. As we’ve seen in the past, sharp corrections are preceded by a slow deterioration in prices. If you follow the trends, and especially my Trend Tracking Indexes (TTIs), you should have ample warning that a directional change has occurred and that it’s time to stand aside.

Right now, market direction is clearly bullish and, who knows, we may very well get to the S&P;’s 1,500 level, which Grantham refers to as bubble territory. Ride the bull for as long as it lasts, but remain aware that a directional turnaround is lurking on the horizon.

Make sure you have your exit strategy in place—just in case Jeremy Grantham is right again with his prognosis.

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Comments 4

  1. Newbie question: I have $20000 in my IRA (invested in stocks and a mutual fund index). What do I do once the signs of a bubble popping appear, just sell and keep it as cash?

  2. That's the idea. Once the trend reverses from bullish to bearish, you want to move to the sidelines first and then assess if there are any areas developing upward momentum before making any new commitments.


  3. To me, the market, right now, seems to be moving sideways, rather than bullish.

    If anyone watched the Oscar-winning documentary, "Inside Job," it clearly showed that there have not been any changes in the so-called "financial reform," which will prevent another crash. I agree with Paul Farrell; a crash will occur. I don't know, if he's right about the timing, but I really believe one will come.

    Your advice, Ulli, is very sound: have your exit strategies in place, which I have taken you to have your stop sells in place and USE THEM, when they hit.

    Thank you for this interesting article.

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