When will the US share market crash?

June 18, 2018

The Austrian School of Economics argues that excess money supply causes inflation.  https://en.wikipedia.org/wiki/Inflation#Austrian_view "The Austrian School stresses that inflation is not uniform over all assets, goods, and services. Inflation depends on differences in markets and on where newly created money and credit enter the economy"  https://en.wikipedia.org/wiki/Austrian_School    Usually, it creates consumer price inflation and aseet price inflation in due course. But sometimes, the inflation occurs in ways that some people were not expecting.  http://www.businessinsider.com/money-printing-caused-asset-inflation-2015-12?IR=T  https://finance.yahoo.com/news/the-fed-caused-93--of-the-entire-stock-market-s-move-since-2008--analysis-194426366.html  Post Global Financial Crisis (2008-2009), developed world central banks, led by the US Fed embarked on a massive round of money printing (which they quaintly called Quantitative Easing - part of what has also been called unconventional monetary policy) in response to what the Bank of International Settlements (BIS, https://www.bis.org/ the central bankers central bank) called a balance sheet recession http://puzzlefinancialadvice.com.au/Balance_sheet_recessions_explained_140922_02_why_West_with_have_slow_growth.pdf. The amount of money printing that central banks have done is reflected by the size of central bank balance sheets (because central banks were buying assets with "newly printed" money).


Therefore, it should be no surprise that the massive money printing has caused massive asset price inflation (not evenly) since 2009. This can be seen in the following charts showing the correlation of the US Fed balance sheet and the US share market (S&P500).


This has in turn (as you should expect), caused some major asset price bubbles, with the US share market one of the most extreme examples - as can be seen from Professor Robert Shiller's long-term chart of the cyclically-adjusted P/E ratio (CAPE) for the US share market (~S&P500) below.  http://puzzlefinancialadvice.com.au/Papers/Shiller_CAPE_PE10_as_a_guide_to_future_performance_130726.pdf


 Now, it is a historical fact that any time since 1880, that Shiller's CAPE ratio got anywhere near the level indicated above (32.11), this was followed by a major crash in the US share market (see chart immediately below for relationship between high CAPEa and share market crashes). This is an ominous warning for index-like investors in US shares. (There are some other asset sector and markets which are also in asset price bubbles as well of course). Investors ignoring this sort of warning do so at their own peril.



But when will the US share market crash?     Fundamental measures like Shiller's CAPE ratio, warning of such an event in the future, but they do not tell you when.  However, there is a reasonable school of thought that suggests as follows. If it was the massive money printing in by developed world central banks (seen in growing central bank balance sheets) that caused the US share market bubble, then "surely" as that balance sheet shrinks (or developed world central bank balance sheets more broadly), then so will the US share market bubble. Personally I think this is quite likely to be the case.   And so does Gavekal https://web.gavekal.com/, a highly regarded research house based in Hong Kong.  https://www.puzzlefinancialadvice.com/single-post/2017/10/18/Recession-risk-warning-for-2019



Another factor which seems likely to tell us something about the timing, us the US Fed cash rate.  Historically, rising US cash rates have been highly correlated with financial crises. Note: Over the last few days, the US Fed has raised its cash rates by another 0.25%, and expects to raise US cash rates another 2 times before year end.  https://fred.stlouisfed.org/series/FEDFUNDS   https://fred.stlouisfed.org/series/TB3MS   

 In this context, it is worthwhile reviewing the current intent is for the US Fed regarding cash rate changes, based on current thinking.  https://www.bloomberg.com/graphics/fomc-dot-plot/   https://www.thebalance.com/what-is-the-fed-dot-plot-416891  Fed Funds target upper limit  https://fred.stlouisfed.org/series/DFEDTARU       Current summary of Fed Fund rate forecasts      https://fred.stlouisfed.org/series/FEDTARMD  









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