Growing Trend Could Spark the Next Stock Market Crash

Indicator Predicts Next Stock Market CrashThis Indicator Predicts Next Stock Market Crash

After a disastrous start to the year in January when we saw a stock market crash develop, the stock market picture has shown improvement. This shouldn’t be a surprise given the overblown selling capitulation.

In March, we saw investors return to chasing risk and returns, driving up the small-cap Russell 2000 by more than 7.3%, slightly edging out the Dow.

The reality is that the celebrating on Wall Street was largely driven by the continued flow of easy monetary stimulus into the global economies, a factor that helped to give us the relentless six-year bull market, which could create a stock market crash.

First, Japan adopted negative interest rates. Next, we heard the announcement by the European Central Bank (ECB) that it would continue to pump money into the eurozone economies.

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Domestically, the Federal Reserve is going back to its old tricks. The central bank cut its planned rate hikes to two for this year from the previous four. Fed Chair Janet Yellen then confirmed the central bank’s dovish strategy last week after suggesting the Fed would be careful in raising rates so as to not impact the country’s fragile growth, given the negative impact from China and other economies.

Standard & Poor’s just cut its outlook for China to negative and we are seeing gross domestic product (GDP) downgrades to as low as 6.3% for this year—well below Beijing’s targeted 6.5% to seven percent.

With U.S. GDP growing at an annualized 1.4% in the fourth quarter and ramping up to an optimistic 2.1% for the first quarter, along with inflation that is under-controlled, the Fed can continue to pursue its stock-supportive easy monetary policy.

Market Trading at Excessive Multiple

Yet while the stock market bulls are currently rejoicing, April will bring anxious moments given the reporting of first-quarter results.

The slightly positive stock market bias will come under attack as we move towards the first-quarter earnings season beginning with Alcoa Inc (NYSE:AA) reporting on April 11.

The current prognosis doesn’t look good and with the S&P 500 already trading at a hefty 17X (times) forward earnings, you really have to wonder how stocks would move higher. We could certainly see a stock market crash.

Earnings Look Horrible

The estimated earnings for the S&P 500 companies are predicted to contract 8.7% in the first quarter, representing the fourth straight quarter of year-over-year declines, according to FactSet. (Source: “Earnings Insight,” FactSet, March 24, 2016.) The concern is that unless we see an earnings recovery, the S&P 500 will likely see its price-to-earnings multiple rise to even more unrealistic levels and leave the index vulnerable to a stock market crash.

According to FactSet, the weakest areas are expected to be energy, materials, and industrials. Only three of the 10 sectors, including telecom services and consumer discretionary, are expected to show improvement.

The first quarter, if it is as bad as we think, could drive a stock market crash to the February 11 lows.

Consider that of the 119 S&P 500 companies that have issued guidance, a whopping 93 companies issued negative earnings guidance. Moreover, the results are based on already-reduced earnings estimates, so it is not a good sign.

The revenue side looks equally bad, with S&P 500 companies expected to see first-quarter revenue contract 1.1% versus the expected 2.6% growth predicted at the start of the year. This would be the fifth straight quarter of sales contraction.

The bottom line is that other than the concerted efforts of the central banks to provide liquidity to a somewhat broken system, there is really no valid reason for the market to move much higher and we could see a stock market crash.

But again, the stock market has proven that it is often irrational.