Some experts are forecasting a new market crash to occur sometime in the near future.
The reasoning to justify this call is that the U.S economy hasn’t improved its fundamentals during the last 12 months and, thus, the recovery isn’t self-sustainable.
We have seen a powerful bounce in economic activity and the equity markets due to aggressive monetary policy and out-of-control deficit spending by the government that amounts to 12% of gross domestic product, or GDP.
However, private-sector credit continues to contract, unemployment remains near 10% and the housing sector still isn’t recovering. These are vital components that need to reverse their downward trend to sustain a durable economic recovery.
Thus, if interest rates are raised by the Federal Reserve and, at the same time, the Obama administration cuts their spending, the economy would quickly enter a double-dip recession.
The markets are discounting continued growth; the S&P 500 is currently priced at a 19.8 price-to-earnings ratio for this year´s first quarter.
If the stimulus measures are removed, then I completely agree that the market would crash due to its high valuations.
The problem with the crash forecast is that politicians aren’t going to stop the deficits and their easy-money policies.
They will try to keep propping up the markets and kicking the can of the economic problems that plague the U.S economy for as far as the eye can see.
The latest Congressional Budget Office, or CBO, report stated that it expects that deficit spending would add a cumulative total of $ 10 trillion of debt for the next decade.
By 2020, federal debt will add up to a gargantuan $20.3 trillion, which is about $170,000 per household.
By then, the interest expense of this debt will probably get out of control as interest rates in the long end will start to rise and the government will have to print dollars to finance its own spending.
With that said, the nominal lows we saw in March 2009 will probably hold as the dollar is debased in order to “finance” the deficits. Equities and hard assets will be an inflation hedge and cash will remain a very unattractive asset, making the crash scenario very unlikely.
This doesn’t mean that we won’t get meaningful corrections in the markets.
But in my view, these dips will be opportunities to buy — not because I think the economy is improving but because of the macro and monetary environment we are dealing with.
The next correction in the markets is right around the corner.
The last two important sell-offs in equities have been mid-month during earnings season after the big banks release their earnings.
This has coincided with an extreme short-term bullish reading in the put-to-call ratio, which now stands at 0.54.
Wait for that sell-off and then enter the market long-to-trade with the trend.
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