Fundaments Suggest Stock Market Crash Still Possible
Key stock indices are breaking above their all-time highs, but should you buy? Be very careful if you’re considering stocks. I wouldn’t rule out a stock market crash just yet.
Looking at the stock market from a technical perspective, we have a clear breakout in play—a bullish chart pattern. For instance, pay attention to the chart below of the S&P 500.
The index recently broke well above the 2,125 level (the black line in the chart below), which was acting as a resistance level since early 2015. Every time the index would approach this resistance level, we would see sellers come in and the S&P 500 would drop.
Chart courtesy of www.StockCharts.com
If you look at other key stock indices, the Dow Jones Industrial Average, NASDAQ Composite, and the Russell 2000 Small Cap Index are all above their resistance levels as well.
Stepping back a little from the charts, when you see something like this happening, you must ask one question: are the fundamentals changing as well?
Generally, you want to see prices moving in the same direction as the fundamentals. Sadly, this isn’t happening. Fundamentals remain tormented and are deteriorating. This factor suggests a stock market crash could happen in 2016.
Consider, too, that earnings continue to decline.
In the second quarter, the S&P 500 companies are expected to report an earnings decline of 5.5%. The worst part is that earnings expectations for the third and fourth quarter of 2016 are declining as well. (Source: “Earnings Estimates,” FactSet, July 15, 2016.)
This has been mentioned over and over again in these pages—earnings and earnings expectations matter a lot. If they are declining, a stock market crash becomes a real possibility.
Unfortunately, earnings are just one factor saying a stock market crash is possible—and soon.
Pay attention to valuations, too. It seems investors have completely lost touch with reality in this area. They are giving companies valuations that are just outright scary from a historical perspective. For example, the trailing 12-month price-to-earnings (P/E) ratio for the S&P 500 stands at 19.4. This is its highest level since 2010—and well above the five-year, 10-year, and even 15-year average P/E for the index!
Stock Market Outlook for 2016
You see, there’s only one thing that’s driving the stock market above its previous highs and that’s the low interest rate policies across the globe. Other asset classes outside of stocks aren’t providing enough returns due to low—or even negative—interest rates. Investors searching for yields are therefore running toward stocks. There’s nothing more to it than that.
Here’s how you have to look at all this: low interest rates could drive the markets higher. But, you have to question how high could the markets go up on the back of poor fundamentals.
There’s one more thing that you should keep in mind as well. You see, usually after the breakout, one would assume volume would increase. This is not the case for key stock indices right now. Look at the chart above, for example. In it, you will notice volume has slightly declined! To me, this is a red flag that suggests this could be a “fake-out.” Time will tell.
I reiterate my view: take higher key stock indices with a lot of pessimism and definitely don’t rule out a stock market crash.