Will U.S. Markets Crash Now - Or Later?

Every time I’ve written about the imminent disaster that awaits U.S. stock markets, and subsequently global markets, the response has been overwhelmingly negative. In 2007, when I warned of steep declines in U.S. markets that were on the way in 2008, I was called everything from unpatriotic, to un-American, to even unholy. When steep declines indeed hit the markets to begin 2008 and gold soared to $850, (fulfilling my September 2007 prediction of $850 gold by January 1, 2008), the name-callers merely disappeared.

It’s not that I revel in markets struggling and the still very real possibility of it shedding great value. In fact, I’d be ecstatic if the U.S. markets looked healthy and an imminent rise to a 16,000 Dow was realistic, with an upward surge taking all global markets along for the ride. Good money can be made in great markets or terrible markets so it doesn’t really matter either way. It’s amazing that people think I have an agenda for wanting markets to crash, oddly connecting my market sentiments to arguments about patriotism or religion. It’s just that I feel obliged to report what I see, because so few nuggets of reality trickle through the mainstream information filters and reach larger audiences.

People seem to forget one central and critical point. Most people seem to believe that they have to lose a great deal of money when crises materialize and forget that it is absolutely possible to prosper during crises as well. Thus, because they feel they must suffer during a crisis, the “shoot the messenger of bad news” syndrome commences. That said, I’m still going to state my utter lack of faith in this mini-rally that the U.S. markets are currently experiencing. Due to the huge levels of unaddressed and unsolved risk that still simmers quite potently beneath the surface, with the current “solutions” being implemented today, I honestly can only see two outcomes. Crash now or crash later.

Should an extended rally of the Dow above 13,000 occur, it will serve no purpose other than to create the illusion of wealth, as opposed to the creation of real tangible wealth. The higher U.S. markets rise in today’s environment, the more likely it is that they will fall even harder in the future. Here’s why. Currently, the U.S. Federal Reserve is playing the same shell game that it has for decades, one in which they alternately inflate stock markets and real estate markets. If stock markets are crashing, then they inflate real estate markets, and vice versa. It’s a vicious circle that eventually will collapse under the weight of its own foolishness. In in the late 1920s, in very simple terms, the U.S. Federal Reserve’s solution to forestall a mild U.S. economic contraction and to stop England’s gold losses was to print more money.

This loose fiscal policy directly contributed to an unsustainable speculative run higher in the U.S. stock market, its subsequent crash in 1929, and the onset of the worldwide Great Depression. When the dot com market collapsed in March, 2000 and Nasdaq plummeted 78%, the U.S. Federal Reserve once again decided to run the printing presses overtime. They cut the Fed Funds rate an unprecedented 12 times in a row, expanded money supply enormously with their free money policy, and created a huge speculative, unreasonably inflated housing bubble that is now bursting today. Now that the housing market is deflating, again the U.S. Federal Reserve has once again slashed interest rates like a demon, this time in an attempt to artificially inflate the stock market. However, these solutions only create problems in the future. With repeated applications of this harmful cycle, and significantly more money chasing fewer assets now, this is why we stand at the brink of disaster today. And this is also why all of these smoke and mirror games are ultimately harmful to you if you are heavily invested in U.S. stock markets (for whatever inexplicable reasons) AND U.S. markets continue to feed this current rally.

The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods.

If I didn’t reveal the above paragraph was not one that I scripted, I have absolutely no doubt that there would be a million people out there to deconstruct that as the most stupid thing they ever heard. However, that statement was made by former U.S. Federal Reserve chairman Alan Greenspan in 1966. So consider this. Since President Nixon took the world off the gold standard in 1971, there basically has been no constraining factor as to how much money the U.S. Federal Reserve can print besides the supply of cotton, linen, and ink.

Consequently, U.S. dollar supply is growing by an estimated 16% to 18% a year now, and true inflation (as measured by the formula the U.S. government employed back in 1980) now hovers around 12% in the United States. If Alan Greenspan made that comment in 1966, with an additional 40+ years of dollar debasement, how much more relevant and pressingly urgent is that statement today? Now let’s substitute “stocks” for the words “bond “ and “bank deposit” in the same paragraph above, because it will shed some light on what exactly is causing the rally in U.S. markets today.

The holder of a U.S. stock backed by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of stocks in the economy, prices must eventually rise. Thus the paper stocks saved by the productive members of the society lose value in terms of goods.

And voila, like magic, this is how short-term rallies in stock markets in dire financial conditions are manufactured by the U.S. Federal Reserve. Highly inflated, cheaper dollars also means that foreigners who don’t understand this equation can be conned into buying more U.S. stocks because compared to five years ago, their prices once F/X exchange rates are taken into consideration, are cheap, cheap, cheap. But once foreigner investors in U.S. markets grasp the above explanation, watch out. (For a discussion of historical crises created by similar conditions, please watch the Investment Matrix and Dollar Crisis videos here). Assets valued in fiat currencies during periods of great inflation can actually increase (numerically speaking) while simultaneously greatly eroding your purchasing power parity. In other words, you can become richer in paper reserves but poorer in real wealth at the same time. That is why there will be no real winners (except for the Central Bankers) if this short term rally in stock markets continues and why the longer this manufactured rally lasts, the harder the fall.

One final piece of food for thought. If gold is so speculative and risky and the dollar will rebound significantly as the masses are led to believe, why does the U.S., according to the most recent statistics released by the World Gold Council (March, 2008) hold nearly 80% of its reserves in the form of gold and so little (on a percentage basis) of its very own currency? In terms of tonnage, the U.S. holds more than 2.4 times more gold than any other country in the world and more than 13.5 times more gold than China. Position yourself in hard assets, and if you have the understanding to ride out periods of great volatility, I believe your rewards will be stunning over the next several years.

Comments

[Ker]

Can you explain me this: real inflation is a lot more than reported, agree. then, when commodities prices will be ajusted for real inflation (i don't know, 100%? 200%? whatever) then the stock prices will be ajusted too. It is illogical if oil costs 200 usd you will not ajust prices of other things. And then for example, if you bought Coca Cola at $50.00 it will go up to say $100 or $150. I mean , you can not loose money in the stock market, because your stocks will be going up at whatever rate they print money. So you can't loose in the stock market if you go long. However if you try to short stocks, it is very dangerous because maybe they are loosing value but in dollar amount they are increasing, so you will be negative in your balance when the commodity prices unexpectedly rise.

[AmesTiedeman]

There is no crash now or anytime soon. Period.

[billb]

Keep calling the 'crash', month after month, quarter after quarter ... one day you'll be right. Then you can be the guy that "called" the crash of 20xx and be on CNBC.

[Pauly B]

Right on, any shake up in the world markets will make our markets drop tremendously and possibly even crash. Even if one is a long term investor how long will it take to get back what you lost. Better have some puts on that portfolio.

Also when I get my stimulus check it wont be going to tech or consumer durables, it will only help me pay my grocery and energy bills. That should really help the economy.

[SageNot]

Has it ever occurred to the author that sometimes the messenger deserves to be shot? If it turns out that the S&P lows are in already, what was his point?

Maybe he's too young (or lazy) to research the major difference between this recession-like drop vs. previous recessions. The USA is much more an EXPORT economy than before, & diff #2, look how low our interest rates are vs. previous pre-recessionary times.

It matters Kim, trust me, it matters!

[J.S.]

Nice comment Kerr. I understand your point about stocks. However, hard assets have really outpaced inflation while you can't say the same with returns of U.S. stocks in the past six to eight months. Some hard assets have increased by 50% to 60% during this time, so even with great inflation, your real wealth is increasing by holding hard assets. Right now, gold is rising against all currencies in the world. You can't say the same about U.S. stocks. In addition, your point about commodities being inflated because of inflation is well taken. Do this quick exercise. Go to stockcharts.com and chart the United States Oil Fund (AMEX:USO) for a 2 year period. You will discover that it has risen quite a bit. Now chart it in terms of Euros (USO:$XEU). You will find that in 2 years, even at today's prices of more than $117 a barrel, that the USO is now at the same price it was 2 years ago when charted in terms of Euros. This used to be the argument against gold. That gold may be great for holders of American dollars only but not for Europeans because U.S. dollar devaluation was causing gold to soar only in dollar terms but not in Euros. Today this is no longer true as gold is showing considerable appreciation in terms of all major global currencies.

P.S. to billb, I actually provide very specific guidelines about the fluctuations in global markets to my subscription members about exactly how high and long I believe rallies will last and when corrections will happen. As well, I provide very precise price points for my predictions of hard asset appreciation as well based upon my proprietary strategies. My members know that in September of 2007 when gold was trading at $680 an ounce, I very specifically predicted $850 an ounce gold by January 1, 2008. Gold reached $850 an ounce on January 3, 2008. I told my members to go long in gold stocks on exactly August 17, 2007 if they weren't already long (can't get more specific than that). I also have provided very specific price points for other hard assets as well. In addition, in June, 2006 these were my exact words to my members "If you are in a highly leveraged hedge fund, I recommend immediately divesting of it before you potentially lose everything you have in that fund." So here, I was about 9 months too early. But still, those that remained in select highly leveraged Bear Stearns hedge funds were blindsided and lost everything they invested. My point, billb, is that risk can remain hidden for a long time, but if you uncover it, I believe it is far better to position yourself to benefit from that risk instead of trying to bet against it. So yes, I apologize for my vagueness at times and realize that sometimes my predictions will not have jaw dropping accuracy. But I do believe in playing the odds. If the odds, given the information I cull from non-traditional sources, overwhelmingly favor a market run higher, then I go long in traditional stocks. If the odds overwhelmingly favor a decline, then I go long hard assets and at certain times, short traditional assets. With the U.S. Federal Reserve constantly intervening in free markets and with the finance ministers of G7 nations pledging to manipulate markets from behind the scenes to "calm irrational market moves", yes, it is nearly impossible to predict short-term fluctuations with pinpoint accuracy. However, long-term trends are relatively easier to spot and I have always believed that planning needs to be proactive rather than reactionary. Good investing!

[adan]

i've sometimes thought about that too, that the u.s. has the most gold of any country in the world; and didn't we give the imf a lot of what it has too?

[User 106279]

Dare to dream. Watch companies with global earnings. USD stock market will crash if export markets decline. This is very unlikely to happen over the next 5-10 year period. EPS and growth of those earnings drives market prices over the long term. I see the market fairly if not under valued at this time. Investor's are making decisions more out of fear than optimism at this point in time.

[sieraromero]

Excellent article! I hope more investors try to preserve their hard earned gains in the market rather than try to increase them at this point in time. The crash is coming. It has to! the only question is when !

[irondoor91]

What has been the best performing, most liquid, safest investment over the past 8 years? A money market fund or a CD.

Think about it; no fees, no commissions, no need to watch the financial news, read these blogs or subscribe to the WSJ. You just put it in there and go get it when you need it. US Govt prinicple guarantee also. If you haven't been able to beat the market during the expansion from Oct 2002 thru 2007, what makes anyone think they will do so in the upcoming recesssion?

All have their "theories" and "strategies"... but 99% cannot implement them due to fear. It's not that the game is rigged, its just that there is too much information available, especially for those who invest based on fundamentals.

[wehapa]

The market, which is one measure of the wealth of the country, has historically moved in conjunction with changes in the GNP. This is true of the US (and the same is true of the world's different markets) so in a historical perspective, the long-term trend is up simply because the "wealth" of the nation is growing. In fact, the wealth, measured by the GNP or other acceptable benchmarks, is growing at an accelerating rate. In the middle ages, it might have taken 200 years for the general wealth of a country to double. In our country during the past century, that growth rate is allowing the wealth of the nation to double every 25 years or so...this is reflected in the markets worth or capitialization. As long as the world continues to increase productivity, the long-term trend will be up. It is now and has been far, far better to be an investor than to be out or short.

[ahough]

We have created "cheap" money and the dollar has lost much of its value. This "conservative&quo... government is spending the American people into bankruptcy by shipping "bales" of dollars to the middle east. I have no idea what our foreign policy is and I don't know if anyone knows what our "interests" are in most of the world. We have no monetary policy but just what works on Monday morning. The writer of this article is probably quite correct. We will probably elect the same crowd next time around.

[Blue collarguy]

Financial Guru's have been predicting the monetary/financial "end of the world" longer than I've been alive and here is what I have observed:
Assets rise in value periodically and decrease periodically the same way. Timing, unfortunately is everything and "timing" depends on so many variables that are beyond any one person's control or ability to measure that "fate", "kismet", "luck", etc. and........within what 7 yr. cycle one is born in largely determines one's overall sense of prosperity. Pay your money and make your choice; it's a total crap shoot.

[tallguy]

What most everyone seems to be missing is two things, one, the baby boomers are beginning to start the retirement phase, and much of their money is in stocks. When it is taken out it will have a drain on the value of these companies.

Propabably the biggest one everyone is missing is the only way the U.S. can possibly ever hope to repay it's foreign debt is to inflate it away. It absolutely must have inflation, and the 12% mentioned as the real inflation number is a minimum that it must have. With all our manufacturing jobs being shipped overseas, our net imports will not decrease any time soon. Google Ford China and see what you get, or GM China, or Motorola China or ...... the list goes on.

Our government is no longer We the People, it has become so large it is a self perpetuating entity, and will remain so until some real awareness sets in on the part of the people, which will probably only happen when there is real pain. You won't hear it on CNN, or Nightly Business News, or read it in the Wall St. J.

Great show last night about the Windmill manufacturer Vestas, and the Danish Government.

[tom kern]

hey,after a crash you get insurance to pay for it. then you get up after you fall off horse and keep on going down road.simple formula ,only the numbers in trillions get to be little concerning. only problem is some people get left out of formula somewhat .. NEXT !

[sivere]

The problem is not a crash of the stock market. The real economy is still somewhat functioning. It is being impacted by high fuel prices and commodities. People still go to work, give bitrth, eat food, live in [lower valued] hosues, etc. Life goes on.

The problem is the $500+trillion derivatives bubble that may "crash" at any time. This will impact the real economy if farmers cannot get loans to keep running there farms if people cannot get loans to finance their homes, if producers of stuff that people need cannot finance the machines and supplies they need to make the stuff.

This is all the fault of the Fed and its policies of the last 20 years (at least). As the derivative bubble was inflated the Fed stood by, even encouraged it with glee. In fact it is the fault of congress who have the constitutional responsibility to administer and maintain a currency and system of credits. Therefor, we need to

TakBackTheFed.com

We need to do it NOW. Let's not sit around and wait fo the crash, open our wallets, and pay for it (not that what is in our wallets will necassarily be woth much). Let's take action now, and save our nation!

[mark r]

J.S. Kim,
great, very thoughtful post, thanks for putting your ideas out there, these are reactionary times, greed distorts and bends people perspective of things, your post offers a freedom from this mindset...thanks

[ValG]

About stocks and inflation... The one who entered US stock market in 1929 (for simplicity i will assume an investor who bought DJIA), got his money back in about 20 years. Then, those who entered US stocks in 1965, did bothing untill 1985. The 1970's - the hight inflation period, up to 1980-82 - stocks are seemingly good protection against inflation... Well, if adjusted for inflation, it got back where it was only ... in about 1990!!! You'd say i didn't count the dividends. Well, if stocks in portfolio do not pay dividends?
I agree with the author, great article, the world is cyclical, and no EPS, no other "analytical bullshit" can predict anything. One should look at the things on the large scale and not get into wooden numbers

[User 106279]

We live in a great time in history where there is so much opportunity to become wealthy. Through the means of investing I believe anybody can become wealthy. Bubbles are being created all over the place---1st Technology stocks, than came Real Estate, and now certain Commodities. Markets get over valued because of the herd mentality. It still comes down to knowing how to value a stock, real estate, commodity, currency etc. Eventually what goes up comes down and what goes down comes up (to its correct value). No wonder Warren Buffett is so successful---he simply knows how to value things. I cannot see an overall market crash because the market as a whole is fairly if not undervalued at this time. EPS and projected EPS would need to tank before any pending crash. To finish with the extreme volatility in stock prices can create wealth for anyone. For example: Buying at Rimm's lows and selling at Rimm's highs. Literally, $500 is all that anyone needed. Do I need to say more.

[gordon]

great post, JS, but I am pretty sure the auction window opened to the investment banks ($360 Billion "borrowed" so far?) is Paulson's Plunge Team's way of walking this market up. How much of this money is being funneled to dealer's trading desks? Is the Fed officer "in each bank" accounting for this? After all, in the past 5 yrs, 70% of their profits came from trading, right? It's the only thing Bush has not turned to compost yet, and it seems to me very easy to "prop", they can even have a deal to buy between themselves, and Bush has indemnified them from any losses. He can do this using the Patriot Act, as it is according to this loose clause, " national security". Show me evidence this isn't happening, study 5-minute charts of SPY, DIA, first, looking for patterns.

[SaveTheRupublic]

Crash later please.

User 106279
I have $500 bucks. (Not much more then that.) Help a brother out!

[e2800]

The guy is correct as far as the economics of what is happening to the stock market and purchasing power. The only reason it hasn't crashed yet is because there is such a large supply of money propping it up. Where I disagree is in this notion that gold is actually worth something. You can't purchase anything with gold and you can't carry it with you and you can't take delivery of 100 ounces of gold etc etc.. Even as a store of value, I'm sure they were singing the same tune in 1980, and then what happened? People realized you can't buy anything with 100 ounces of gold, you need a dollar.

[steve west]

ZZZZZZZZZZZZZZZZZZZZZZ...
great academic theory... too bad you are wrong and "real life" does not work that way... however keep calling for the crash. I am sure you will be correct in 4-7 years.
Now if you excuse me I need to get back to making money in the real world.. not this theoretical Macro- model that you have dreamed up

[steve west]

one more P.S. here this guys entire life is centered around the coming collapse of the dollar and the U.S. market. seems like he has an agenda

[JimHawthorne]

Thanks for a very thought-provoking article, Mr. Kim!
The decline of the dollar has become painfully well known to any American who has ventured outside N. America lately...
While we toil away "making money" in the markets, we sometimes lose the global perspective that would help us realize that we really have to triumph to create any "real wealth" in global terms.
Many of us here in the States have our heads in the sand.

As an interesting exercise, all some of the skeptics have to do is calculate how much the NA indexes have dropped since October '07 in Euros!!!

[darcydancer]

Nice to see an article that doesn't just repeat the mantras of the cult of equities. I disagree with him as I think the more likely outlook for the broader indices is a sideways grinding market with US consmer based stocks such as SBUX being hurt and export earning driven stocks doing better.

[iThinkBig]

Well, I predict a crash as well, but this will take some time as the problem is Socialized and Main St. is bled dry, finally bringing down Wall St. Banks need customers to lend beyond just each other and the risk is very high and lending very low. If housing has to bottom and inflation looks to continue rising, it makes sense consumers will continue slashing non-essentials and that includes bank loans for toys, vacations, remodeling etc. It's a nasty downward spiral that Washington could fix, but not without some real short term pain and who wants to be the bad guy during an election year?

Such a crash would be short-lived, people will mobilize and we'll be back up in no-time. What's absolute worse case-scenerio, eating government wheat pasta and yellow cheese for three to six months? Great, add some ground hamburg and I'll be fine checking out the simpler things in life such as nature as I await the next massive boom stemming from energy independence.

[User 180260]

A prudent man sees danger and takes refuge,
but the simple keep going and suffer for it.
-prvbs 22:3

The more money you print, the less the dollar is worth,
the more dollars it takes to buy anything.
OPEC says oil is high because the USD is worth squat.
food on the rise as well. everybody spends so much
on gas and food they have no money for everything
else.
The arrogance of some of these comments makes my
stomach turn. So I know, They've got it coming to them
and Even if Abraham, or David, or Solomon where here he
couldnt save even his own son. Time to seperate the usefull
from the uselless, time to purge the foolish from the world.

[mlyn]

To e2800: No, you can't take gold with you, but having a gold standard means the Fed cannot print more money than it has gold in storage. Without the gold standard, or some other standard, to enforce some discipline, the Central Bank, all of them, are printing currencies like you wouldn't believe. It's all "virtual" money too. When the Fed reduces interest rates, I get more credit card offers in the mail. Voila! Instant loan that I didn't ask for, but interest payments ad nauseum to the banks. That's why gold is so important: You can't eat it, you can't put it into the gas tank, you really don't use it up. It's always there as a symbol of REAL MONEY. The only way to have more dollars is to dig up more gold from the ground--if we had a gold standard.

As for oil, it is definitely a precious commodity too. No one talks about conservation and reallocation to alternative energy R&D. We're going to burn this commodity up.

[pooramerican]

Good article, but I agree with the comment:
"Who wants to be the bad guy in election year?"
This is not a free market, I learned the expensive way.
About the dollar dropping, guess what, the dollar dropped the most right around time for earnings then some how magically starts gaining strength before next FOMC meeting.
The notion that foreign investors can't understand the valuation scheme is simply absurd. They are coming in to save the nation's banks, why you think they are doing that?
One last thing, does anyone know what happened to russia when they defaulted on their loans? :)