What goes up, must come down. Just ask Sir Isaac Newton or anyone who has ever invested in the stock market. Great highs can come to a crashing end, as proven by the Great Depression of the 1930s, the dotcom bubble burst in 2001, the housing market crash in 2007, bank collapses in 2008 and the Great Recession that followed. But ever since March 2009, the U.S. stock market has been running with the Wall Street bulls. This current period is the second longest bull run in U.S. history. Why?
Over the past decade, the Fed has kept interest rates very low in an effort to stimulate economic growth. It looks like it’s working, too. Consumer spending is up, employment rates are up, median household incomes are up, the housing market is up and the economy is growing. Low interest rates make it easier to borrow money, and less of an incentive to save it. This stimulates growth, including consumer spending, driving higher demand and price inflation.
The problem is, the rising prices of stocks doesn’t necessarily mean that a company is performing very well. Here’s one reason why - in the past five years, U.S. businesses have spent $2.1 trillion in stock buybacks, according to HSBC. What does that mean? It means companies have been using their cash to buy back stock in their own companies, thereby reducing the number of shares outstanding. That, in turn, increases the company’s EPS value (earnings per share), which also increases its P/E ratio. It’s basic math: $10 in earnings divided by 5 shares = $2 per share; $10 in earnings divided by 2 shares = $5 per share. Problem is, the improved rating isn’t due to increased earnings, just fewer shares. This may be a good short-term strategy, as it improves a company’s image, raises stock prices and entices investors with higher dividends, but it can’t last forever.
The big question is -- what happens next? Some say this is a recipe for disaster.
Who are these bold bears? And more importantly, are they right?
1. The Conservative Bond King
Jeff Gundlach thinks a crash is imminent. He’s the founder and CEO of DoubleLine Capital (the fastest growing money managers in history, with over $100 billion in AUM to date). Why should you listen to him? Well, for starters, he correctly predicted the 2007 housing market crash. Gundlach is generally a risk-averse yet successful bond and commodities guy, so it’s no surprise that he’s anti-stock. According to Gundlach, Brexit was just the beginning. He points to advances in technology as a reason for a labor market that will weaken instead of grow, he’s convinced the Fed will unexpectedly hike interest rates which will reduce consumer spending, and he’s certain that Donald Trump will win the presidential election because, as a parallel to the Brexit vote, people are as mad as hell and they’re not going to take it anymore. He also preaches that, just like Brexit, the immediate economic fallout of a Trump presidency will be great because the media will stir up fear of nationalism, protectionism and noncooperation, as it did during the the Great Depression. Can you say déjà vu? Gundlach can.
2. The Permabear
“We’re all on the Titanic.” Those are the words spoken by economist Dr. Marc Faber during a CNBC Squawk Box interview back in June. Famously pessimistic – he is the publisher of The Gloom, Boom and Doom Report, after all – Faber is a Swiss investor who has been openly critical of how the world banks pump money into economies, falsely inflating them, as he says the Fed is doing in the United States. More recently, Faber warned that after the S&P 500 reaches 2,300, the stock market will explode faster than a Galaxy Note 7 phone, crashing down to 1,100. In his all-hell-breaks-loose scenario, he thinks the only safe bet is gold.
3. The Eternal Cynic
Jim Rogers, co-founder with George Soros of the uber-successful Quantum Fund, recently took Faber’s predictions one step further, calling for a market crash of biblical proportion. Citing what he calls artificial money printing and debt expansion, the legendary investor predicts a $68 trillion (yes, trillion with a “T”) collapse this year. Or next year … or maybe the year after that. No one knows for sure, but Rogers is sure that the inevitable stock market crash will be bigger than the one in 2008 because economies around the globe – U.S. included – do not have any money in reserve. It was used to recover from the Great Recession. Rogers’ advice: Sell everything, invest in commodities (especially gold) and teach your kids Mandarin Chinese because only China will survive this global chaos.
That’s a lot of negativity. Is the sky really falling?
People have been forecasting a stock market crash for years now, saying the bubble is about to burst. “Any day now,” they say. And they say it every day. But here’s the thing with permabears like Faber and Rogers, and to some degree Gundlach: Like broken clocks, they’re right twice a day.
The reality is, the stock market goes up and down. Sometimes further down than other times, but it has consistently and historically rebounded. And if you’re an investor with a long time horizon, a strategy that focuses on the long term has historically been the best approach to riding the market’s waves.
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Commentary is provided for educational and informational purposes only and should not be considered as investment advice. Investing involves risk, including the risk of loss. Before investing, consider your investment objectives, financial resources and risk factors.