U.S. Senator Ted Cruz and reality TV spectacle Donald Trump both say a U.S. stock market crash is imminent. Trump said recently that an overvalued stock market would lead the U.S. into a recession. This past Friday, Cruz said the Fed has juiced the system, potentially bringing on a stock market crash.
Is Ted Cruz onto something?
Ted Cruz: Stock Market Crash is Coming
Senator Ted Cruz recently said in an interview that “using monetary policy is a very ineffective way to juice the system because you create bubbles.” He went on to say that the Federal Reserve’s overly generous monetary policy is responsible for driving up stock prices and asset values. (Source: “Ted Cruz: Why a stock crash ‘will be coming’,” CNBC, April 15, 2016.)
Cruz contends that the long-suffering bull market is not built on an increase in the intrinsic value in those assets; it’s just based on playing games with money, which means a crash is coming.
Love him or hate him, Cruz is fundamentally right.
Stock prices increase because there’s production and the companies are worth more. But that’s not happening right now. We aren’t seeing economic growth either here in the U.S or abroad.
More and more central banks around the world are adopting negative interest rates. Not surprisingly, their economies have not responded the way the central banks thought they would. Global growth is anemic and the outlook for the next two years is bleak, with the International Monetary Fund (IMF) cutting its economic gross domestic product (GDP) forecast to 3.2%. This is down from its 3.4% estimate in January. (Source: “World Economic Outlook,” International Monetary Fund, April 12, 2016.)
Historically, since WWII, the U.S. economy has grown, on average, at an annual rate of 3.3%. Since 2008, the U.S. has been addicted to economic mediocrity, averaging annual gross domestic product (GDP) growth of just 1.2%. (Source: “GDP Growth (annual %),” World Bank web site, last accessed April 15, 2016.)
And those numbers are bearing out in weak quarterly earnings. In the first quarter, the expected earnings decline for the S&P 500 is an eye-watering -9.3%. That number continues to sink. Last week, it stood at -9.1%. For the week ended April 1, it was -8.5%. This estimate is just a sliver off the expected 0.7% growth rate that was forecast at the start of the quarter. (Source: “Earnings Insight,” FactSet, April 8, 2016.)
If the S&P 500 reports a decline in earnings in the first quarter, it will mark the first time the index has seen four consecutive quarters of year-over-year declines in earnings since the fourth quarter of 2008 through to the third quarter 2009 (i.e. the Great Recession).
Yet miraculously, the S&P 500 continues to trade near record levels.
Monetary Policy Ineffective Way to Juice the System
Cruz is correct when he says the Fed is behind the long-in-the-tooth bull market and that the increase isn’t based on strong fundamentals. There’s more to consider than just the last four consecutive quarters of declining earnings.
In 2013, a year in which the S&P 500 soared around 30%, in each successive quarter, a larger percentage of companies revised their earnings guidance lower. In the fourth quarter of 2013, a record 88% of S&P 500 companies revised their earnings lower.
But let’s stay in the present. What the last eight years of quantitative easing (QE) and artificially low interest rates have taught us is that the Fed’s monetary policies are an effective way to raise stock prices but an ineffective way to promote real, sustainable growth.
The bull market may have just celebrated its seventh anniversary but few are cheering. Earnings and revenues, who needs them? New research shows that the Federal Reserve is responsible for 93% of stock market moves since 2008. (Source: “The Fed caused 93% of the entire stock market’s move since 2008: Analysis,” Yahoo! Finance, March 11, 2016.)
You can’t fight the Fed. That’s pretty evident. But when the global cartel of central banks pulls its collective finger from the dike, investors won’t be able to ignore an overvalued equity market supported by declining revenue and earnings.
Brace yourself for a stock market crash.