A global market crash is coming, and investors should prepare accordingly.
The stock market, bond market, and real estate market are all in bubbles. None of these asset classes will be protected from the crash that is likely to come. The writing is already on the wall, too. For example, we can see massive levels of volatility in the S&P 500 (^GSPC) , Dow Jones Industrial Average (^DJI) , Russell (^RUT) , and Nasdaq (^IXIC) already, and it will get worse.
The asset bubbles in these asset classes are a direct result of central bank stimulus. As recently as September, the combined effort of global central banks was buying $60 billion of global assets per month, and that was a regular occurrence since stimulus was first introduced by Ben Bernanke on the heels of the credit crisis. Quantitative easing part two was also specifically geared towards supporting asset prices, just liked the corporate bond purchases of the European Central Bank were.
With the goal of increasing asset prices and inducing the wealth affect to spur economic activity, the central banks bought assets aggressively for years, and it worked to at least calm the nerves of investors. Institutional investors even piggybacked on this effort. The central banks, after all, told us what they were going to buy, when they were going to buy it, and how much they were going to buy in advance every month. Never has there been so much disclosure, but now that is changed.
Anyone who appreciates the simple notion that price is a function of supply and demand recognizes that the substantial capital inflows from the combined central banks spurred asset prices higher for years, and most investors did not want to fight it, with justification.
However, given the changes that are happening to liquidity many of those same investors are not appreciating the risks quite yet. If high levels of fabricated demand served to increase asset prices, the opposite is likely when those asset purchase programs reverse as they are now.
Therefore, in one instance central bank stimulus is now a drain on liquidity and the high valuation of the stock, bond, and real estate markets are being questioned as risks are being reassessed.
In addition, without the fabricated demand of the central bank stimulus efforts the demand for these assets is also left to natural forces. Until stimulus was introduced after the credit crisis, natural demand for stocks, bonds, and real estate was based on a simple derivative demographic analysis.
People invest money according to ingrained societal norms. They grow up, get married, buy a house, have children, put their children through school, retire, and die. When these long-term ingrained societal norms are measured against long term economic and stock market cycles we can see a direct correlation as well. This is identified by The Investment Rate. This proprietary measure of the rate of change in the amount of new money available to be invested into the U.S. economy further tells us that we are in the third major down period in U.S. history. This is just like the Great Depression and stagflation because the rate of change in the amount of new money available to be invested declines every year.
The declines illustrated by The Investment Rate began in December of 2007, and that was identified five years in advance. This is a leading indicator of natural demand levels, and it has shown us a direct correlation to longer term cycles that date back to 1900. The only blip has been during the central bank stimulus phase, where fabricated demand was poured into the global economy.
Now that fabricated demand is over, natural demand levels will prevail again, but natural demand is also far lower than where current demand still is perceived to be. According to The Investment Rate, we are in the third major down period in U.S. history, and now central bank stimulus efforts have turned on their head. That creates a double drain on demand.
The stock market, bond market, and real estate markets are set up for a crash based on simple liquidity observations. Price is based on supply and demand, and demand is cratering.
Written by Thomas H. Kee Jr., President and CEO of Stock Traders Daily.
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