Why Stocks Won’t Crash

It seemed like only a week ago when permabears were predicting the appearance of a new bear market that would take out the lows of 2009. The variables all seemed to be there: Greek debt crisis, inflation from higher commodity prices, and worsening economic data in the U.S. Most economic observers believe these kind of variables lead to lower stock prices. As you can clearly see, this is not the case.

There will be a lot of buying pressure in stocks due to: 1) the flight to liquidity, and 2) the attempt to hedge against inflation. As long as bond yields remain incredibly low, stocks are a viable investment option, even for retiring Boomers who have been brainwashed into believing there is some magic bond to stock ratio you must follow as you age. Such rubbish. Every era is different: sometimes you have good leaders, sometimes bad leaders; sometimes you are on a gold standard, sometimes you are not; sometimes taxes are low, sometimes they are high. You must use your common sense or risk losing all your retirement savings.

I have consistently said that there won’t be another stock market crash along the lines of what we saw in 2008. The positive correlation between stocks and the economy is far from absolute. In the current economic environment, rising domestic stock prices are actually bad in a way because it evidences a growing lack of confidence in the U.S. dollar. As I’ve said before, stocks rose in the 1930′s because we were on a gold standard and the flight to safety to gold was effectively a flight to safety to the dollar. This created the deflationary environment that exacerbated the stock market crash. We now essentially have the 1930′s situation in reverse: a flight to safety to gold is a flight out of the dollar.

What to look for now is rising inflation along the lines of what we experienced in the U.S. following FDR’s confiscation of gold. The dollar was untethered and this led to a rally in stocks and real estate even with about 20% unemployment. While our situations are somewhat similar, we also face a debt crisis that threatens to undermine the dollar. That being said, I would not be surprised if stocks double or tripled in the next 5 years. The debt crisis will wipe out bondholders, which means people have to put their capital somewhere. Stocks and gold are the likeliest candidates to receive massive inflows of hot money.

The coming years will likely be profitable for those who maintain a bullish bias in stocks, commodities, and gold. Besides minor reactions these markets are poised to rise dramatically because of the devaluation of the dollar and the concurrent loss of confidence. The thing to remember is that Treasuries are government debt, which means they will eventually fall as the public’s confidence in the government falls. This leads to a cascading effect in all other type of bonds, and in the worst case scenario, a panic. It is virtually guaranteed that money will panic out of bonds in the same way it panicked out of real estate. Our job is to figure out where that money will find a home and why. Believe me, conventional wisdom will do you no good in the coming years- it’s time to think independently and intelligently.

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  • Docarpel

    It is refreshing to follow a blog that gives some confirmation of one`s own sanity.
    There is so much BS flying in the face of common-sense that we reach the conclusion that logic
    is out of date and anything can replace it………….
    You are the anchor for the common man: a place where his intuitive sense for truth finds a haven from the storms of insincerity crashing over our heads.
    Your voice is No.1, with my morni.ng coffee: a compass in the right direction.
    Keep it up!

    • http://www.expectedreturnsblog.com Moses

      Thanks Docarpel- just doing my best.

  • keith

    While I agree with the overall argument the one thing bothers me. Assuming bond holders are indeed “wiped out” due to falling bond prices thereby contributing/causing an exodus to stocks, commodities, etc., I wonder about the extent and timing.  That is, as bond prices drop yields increase and higher yields/returns may make reinvesting in bonds, at some point, more attractive than stocks.  Anyway, the dynamic between prices, yields and returns of all investment classes is perplexing to me at best.  Your thoughts?

    • http://www.expectedreturnsblog.com Moses

      I think the timeframe from when bonds start showing weakness to when they become a viable alternative to stocks will be measured in years. I probably wouldn’t touch bonds until long-term yields touched 10% or so. Assuming stocks rally while bonds collapse, this should leave a satisfactory margin of safety in bonds on a bond yield to dividend yield basis. 

  • observer

    all asset classes are overpriced and expensive right now. we briefly hit single digit PE on the s&p – that’s not how bottoms are formed – a lot of the cheap money excesses need to be flushed out. companies are hoarding cash because they don’t see much opportunity to invest it in their business. 

    all bonds have pitiful yields (artificially low). the dollar looks like it will bounce back in the short term since its been beaten up so much…

    but, my preference is to hold cash in the mean time because it looks like we are about to get a good (much needed) correction.

    i do agree that stock will probably do very well in the next 5 yrs, but i think we will get a big dip before that happens.

    • http://www.expectedreturnsblog.com Moses

      Most asset classes have gone on quite a bullish run, I agree. But we need to figure out relative value and incorporate the devaluation of the dollar into our analysis. Is silver overvalued at $35 dollars when it was $50 dollars 30 years ago? Is oil overvalued when most of the major oil fields are peaking in production at the same time emerging markets are increasing their demand for oil?

      As far as companies hoarding, there have been something like $160 billion in announce share buybacks so far this year. Companies were hoarding cash as the stock market made a historic rally, so I wouldn’t give them too much credit in terms of forecasting. 

  • Tforthomas

    Some of these economic writers remind me of Hansel and Gretel….leaving crumbs behind to find their way back. Of course the crumbs are eaten on their path and it is their excuse for never finding their way back to original positions. I know the variables are always changing…..the one reference to our debt is the most compelling variable in front of us. My question is, how many investors are going to immediately trust a country that has allowed this to occur and those companies with in? My dollars are going into gold and silver until I see what the “new” rules are going to be.

  • Tooppy

    I would agree with the general idea if the coming troubles were going to be just that “troubles”. But this time look a lot different, we are going to face a complete civilization transformation and the present reasoning wont apply. In such time we’ll get back to vital items and the only moneys of all times “precious metals”. Many companies have useless activities, they will disappear, many are empty bags without assets and factice capital. As the stock market is full of those, it will crash, except for a bunch of solid productive companies whose stocks will do well.
    Now to use intuitive senses to find the right stocks, you must have an idea of the new world organisation. For example, I predict that “industrial agriculture” will disappear as it is a complete nonsens altogether, food production has to be local, not even from one state to the other, “local”! Water is vital and we have spoiled it! Etc… then watch if the trends follow you predictions and chose your stocks accordingly.
    As for long term bonds the cold shower will be reminded for a long time if such thing still in existence.

    • http://www.expectedreturnsblog.com Moses

      While we will experience profound changes in our economic and political structure, I don’t think we will go back to precious metals as the only form of money. The floating exchange rate system with fiat currencies works fine. The only problem I see is the U.S. having reserve currency status. This should change though as a new global currency is most likely in the cards.

      Some stocks will crash, as they always do. The thing is, U.S. companies are not necessarily dependent just on the U.S. consumer anymore, so they will do just fine if the global economy does well. 

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