The Crash of 2018 Gets a Second Wind

In The Crash of 2018 I made my case that the downdraft in stock prices in the first half of October was just one squall in an ongoing bear market in stocks.  Some of the arguments had their genesis in 2018, for example the divergence that developed between the US market and the rest of the world.  But we’ve been preparing for this for nearly four years.  The current bear market first showed up on our radar screen at the beginning of 2015, when we ran the annual four year Synthetic Systems forecast for that year.  These forecasts are published under the Market Analysis menu link. 

Since then each annual update repeated the same refrain.  As the details evolved, the basic message remained; the bear would return in 2018.  The latest Systems iteration is on the Quarterly page, and new Annual and Quarterly updates are expected around New Year’s.  The persistence of forecast features over successive updates is an indicator of confidence, so all that remained to confirm the bear market forecast was to see the whites of its eyes. 

It’s safe to say we’ve now seen those whites.

But today we can add yet another exhibit to our collection of evidence.  The S&P 500 broke below both the previous lows of what might otherwise have been a triple bottom since the beginning of this quarter.  What’s more, it closed below them not only on a daily basis but concluded the week below them as well.  This opens what the estimable John Hussman might refer to as a trap door under the market.  From a technician’s viewpoint, this means there is no support under the market price structure for a considerable ways down.  Sven Henrich at Northman Trader calls our current juncture mission critical.  By my reckoning, the next meaningful support for the S&P 500 is several percent lower, in the 24XX range, based on another leg of around the same magnitude as the initial drop.

But let’s not lose sight of the forest for the trees.  Speculating about short term market prognoses is challenging and fun, but the important message is that there remains a high probability of further losses in the market such that the overall decline from this year’s highs could be in excess of forty percent.  Investors who maintain balanced diversified portfolios such as the 10-40-10-40 model described under An Investing Primer should see much more modest declines and be prepared to take advantage of rebalancing opportunities over the coming year.  As I posted last week in A Bull Market Is Born, Treasuries appear to be in a new bull market, and gold in an ongoing bull market.

There’s a lot of Monday morning quarterbacking in the financial media about why this is happening on the part of a lot of pundits who didn’t see it coming.  That’s just more trees.  The Fed is raising rates.  International trade has grown contentious and tariffs are being imposed.  There are always plenty of hooks to grab our attention as putative explanations for market declines, but they’re mere distractions.  If these were the real causes of the bear market, then how did Synthetic Systems foresee it at the beginning of 2015?  Donald Trump wasn’t even nominated, let alone elected President, Janet Yellen, not Jerome Powell, was leading the Federal Reserve, and the first interest rate hike was still nearly a year off.

There is one and only one reason why stock prices should go down, and that’s that they were too high.  Central banks floated them on a sea of liquidity.  Many pundits still insist there is no reason for stocks to go down because “the fundamentals” are great.  The economic data are fine, and corporations are profitable.  That’s all beside the point.  Stock prices just plain got too high.  Nothing has to go ‘wrong’ for them to return to normal, all that is required is that the financial backdrop return to normal.  Did we really think it never would?

Some might call me a pessimist because I think stock prices will go down more.  But if they’re too high, then correcting that mispricing is a good thing, no?  I am optimistic that stock prices will return to more normal healthy levels.  And why should high be better than lower in the first place?  Sure, it is if you’re a seller.  But if you’re a buyer, low is better, right?  Why does our financial media culture, which is always urging us to buy, take the side of the seller in celebrating higher prices?  Just something to think about.

So this is all good news as far as I’m concerned.  Finally a generation that has been trying to invest for retirement will have a chance to buy stocks at prices that offer an opportunity to earn something approaching historical returns.  It should be welcoming this bear market with open arms.  

Lower stock prices ahead?  Awesome!

3 thoughts on “The Crash of 2018 Gets a Second Wind

  1. Llanlad2 says:

    Thanks for the latest update. And I wholeheartedly agree with lower prices being good for buyers.
    I think a lot of the reason for the “celebration” of higher prices is because over the last 20 years the “financial” economy has been seen as the driver of wealth and taxes rather than the real productive economy. And consequently stock market crashes have been seen as bad for the economy as a whole.
    Will the real productive economy (and all the every day folk it employs)be able to avoid the fallout of a crash? And will the Fed let it happen?

    1. Bill Terrell says:

      Good point, LL. The perception that higher stock prices are good for the economy isn’t completely without basis in reality. In the short run it seems to be. I would just cite the drug metaphor we used in Why Can’t the Economy Handle Normal Interest Rates?.

      Imagine someone trying cocaine for the first time. ‘Okay, this made me feel good. Cocaine must be good for you.’ This is the depth of analysis behind the notion that high stock prices are good for the economy. They give a nice boost while they’re happening. Only later when the high wears off do you realize that you’re worse off than you were before. Then you try to get the high back by blowing another bubble. Then another. This pretty much sums up our experience with the Fed since 1995!

      Your questions might have been rhetorical, but I’ll take a poke at them anyway. The costs and benefits aren’t evenly distributed. Mostly the owners of assets benefit from inflation in asset prices, but when the air comes out everybody suffers. In the long run, I don’t see how asset wealth can outrun real wealth regardless. Assets are after all ultimately worth only what you can buy with them. The Powell Fed will probably try to steer a middle ground between trying to sustain the bubble and complete withdrawal. I don’t think Powell or anyone else wants to crash the markets or the economy, but also recognize that the prior path is unsustainable. I think they’re in search of the equivalent of monetary methadone; a completely pain-free withdrawal isn’t an option.

  2. Llanlad2 says:

    Thanks for the reply.
    I like the drug addiction analogy.
    I suppose we can be grateful that the US Central Bank Chairman has at least recognised there is a drug problem unlike the more recent heads of the New York Monetary Cartel!