A sudden and steep stock market correction can come at any time, and without any warning or obvious cause, according to Robert Shiller, Yale University economics professor and Nobel Laureate, in remarks on CNBC. While many investors wonder what will trigger a correction of 10% or more, if not a full-fledged bear market decline of at least 20%, Shiller told CNBC, "it doesn't need a trigger, it's the dynamics of bubbles inherently makes them come to an end eventually."
Shiller also told CNBC that the long bull market in the U.S. is part of a "world story...that's driving markets up at this time." Thus, just as an upbeat global economic picture has been a major factor sending U.S. stocks upward, negative news from anywhere around the planet could trigger a crisis of confidence among U.S. investors. (For more, see also: 5 Global Risks That Could Hammer Stocks in 2018.)
Since its previous bear market low, reached in intraday trading on March 6, 2009, the S&P 500 Index (SPX) has more than quadrupled in value, gaining 326%. Over the last three years, since the close on January 23, 2015, the increase has been 38%.
Among the many indicators that raise fears among conservative investors today is the growing popularity of momentum investing, in which the hottest, most expensive stocks are being chased regardless of fundamentals, sending their valuations up to yet more dizzying heights. Those with long memories will recall that the dotcom bubble of the late 1990s grew as a result of a similar mindset among investors. Indeed, another parallel between the dotcom bubble and today is the crowding of investors into richly-priced tech stocks. (For more, see also: Why Stock Investors Play the Risky 'Momentum' Game.)
While stock prices have been buoyed by robust corporate earnings reports and forecasts, analysts at Paris-based Societe Generale SA have sounded their own word of warning, Bloomberg reports. Looking at the S&P 500 minus financial and energy stocks, they find that the growth rate in operating cash flow has been declining steadily since 2013, dropping to a projected 0% in 2018. In concert with a flattening yield curve, which normally signals an upcoming recession, this deterioration of cash flow means that the "equity markets could be in for a nasty surprise," as Bloomberg quotes from the SocGen report.
Shades of 1929
Shiller is best known as the developer of the CAPE ratio, which compares the value of the S&P 500 to average EPS over the prior 10 years. Setting off alarm bells for risk-averse investors, CAPE is now registering loftier valuations than existed before the Great Stock Market Crash of 1929. Only during the dotcom bubble did CAPE rise even higher.
On the other hand, market guru Rob Arnott of Research Associates points out that CAPE has been rising over time, and asserts that this is justified by economic fundamentals. Also, he finds that the CAPE today has a much smaller upward deviation from trend than in 1929. The Financial Times, meanwhile, notes that CAPE does not consider interest rates. Today's low rates, lower than in 1929, make high stock valuations economically rational, the FT indicates. (For more, see also: Why The 1929 Stock Market Crash Could Happen in 2018.)
Predicting the Housing Bubble
Shiller's fame rests partly on his identification of a growing U.S. housing bubble in 2003. This was followed by the subprime meltdown that began in 2007, and that, in turn, was a factor in creating the financial crisis of 2008. According to Forbes, Shiller was among several economists warning of a housing bubble in 2003, while the most prominent figure who denied its existence was Alan Greenspan, Federal Reserve Chairman at the time. More recently, Greenspan has sounded the alarm about a bond market bubble. (For more, see also: Stocks' Biggest Threat Is a Bond Collapse: Greenspan.)