You've Been Warned: This Rally Will End in an Epic Crash

You've Been Warned: This Rally Will End in an Epic Crash

Unless you've been living under a rock, you'll know that last week the Dow passed its nominal high of five years ago.

There has been much pompom waving in the mainstream media. Even discredited forecasters now feel it's safe to start regurgitating failed predictions of stocks going to the moon.

Take economist Kevin Hasset. In 1999, along with James Glassman, he wrote Dow 36,000, which forecast that the Dow would reach 36,000 points "within three to five years." Despite getting it spectacularly wrong in 1999, he was back on Bloomberg last week with the same prediction.

This is a silly distraction. The real question is where would the Dow be if the Fed were not corralling investors into stocks by wiping out yields on bonds?

The answer is a lot lower.

Here's how legendary investor Stan Druckenmiller put it on CNBC last week: "If you print enough money, everything is subsidized – bonds, stocks and real estate." (You can watch the full interview here.)

Druckenmiller was George Soros's lead portfolio manager at the Quantum Fund and the architect of the pound sterling short that "broke the Bank of England" in 1992. He also has an astounding track record – averaging 30% returns over 30 years.

And what he sees now is the mother of all market manipulations... and an epic crash... caused by the Fed and other central banks.

Here's how he put it on CNBC:

I don't know when it's going to end. But my guess is it's going to end very badly. And it's going to end very badly because, again, when you get the biggest price in the world, interest rates being manipulated, you get a misallocation of resources and this is going to end in one of two ways: with a malinvestment bust which we got in 07-08. [...] Or it could end with just monetizing the debt and "off we go" inflation. So that's a very binary outcome. They're both bad.

I am not saying that stocks can't go higher from here. The Fed is printing $85 million a month and has promised do to so until the official unemployment rate comes down to 6.5%.

What I am saying is that the party is going to end badly. Just like it did with the housing bust in 2007-08 and the stock market crash in 2008.

Here's what's important to understand: Stocks seem like a good deal because the Fed has evaporated yields on bonds. But on an absolute basis, they are not a great value.

The dividend yield on the more widely followed S&P 500 is just 2% – nearly 120% below its historic average. And its price-to-earnings ratio, based on 12-month report earnings, is 17.6 – more than 13% above its historic average.

Here's the argument, from the introduction to their book, that Hasset and Glassman used back in 1999 to sucker millions of Americans into a falling stock market:

[We] will convince you of the single most important fact about stocks at the dawn of the twenty-first century: They are cheap. [...] If you are worried about missing the market's big move upward, you will discover that it is not too late. Stocks are now in the midst of a one-time-only rise to much higher ground – to the neighborhood of 36,000 on the Dow Jones industrial average.

This argument was wrong then. And it is just as wrong now.

You've been warned.

Good investing,

Chris


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