10 Signs the Stock Market is About to Collapse

Despite a thirty-percent correction last year, investors have enjoyed a twelve-year-old bull market.  Even amateur traders have been able to bet against hedge funds and drive up some stock prices to triple digits.  Cryptocurrency has been a sandbox for savvy investors as the crypto space promises to change financial markets as we know it.  Interest rates are at historic lows, and the Fed keeps borrowing in the present for an uncertain future.  It’s all very reminiscent of the late nineteen-nineties’ dot-com boom, and Bearish signals are starting to outweigh the Bullish ones.

While I will be the first to tell you I am not an economist and I don’t recommend any investment over not investing at all, I think it’s worth paying attention to right now.  Many of the signs we see today, many of the historical highs and lows, are likely a harbinger of much darker days ahead.  Every sunrise has a sunset, and our economic health is critical to our fragile infrastructure.  If the markets collapse, so can other things we rely upon, like utilities, infrastructure, and our food supply chain.  

In this blog, we will look at a few key indicators that parallel the crash of two-thousand, and we will examine the possibilities of a crash this year.  Are we about to go over the cliff again?  Can we recover from this one?  The second video will look at practical things you can do today to insulate yourself and protect yourself from a crash.  The three-part series’s final video will look at why a crash may not be imminent to provide you with a 360-degree view of the threat and what you can do about it.  So let’s jump in.

IPOs & SPACs

Initial Public Offerings or IPOs are offerings of stock in a company.  You have probably heard of those.  While IPOs dipped a little in the recent past, 2020 had 538 IPOs, which was right in-line with the average 500 public-market debuts from 1995 to 1999, before the crash of 2000.  You may not have heard of SPACs, though.  Almost half of those 538 IPOs were SPACs or Special-Purpose Acquisition Companies.  Those are shell companies in search of a business.  A SPAC is explicitly created to pool funds to finance a merger or acquisition opportunity within a set timeframe. The opportunity usually has yet to be identified.  Just as people invested in vaporware that was merely a concept during the dot com bubble, people invest in SPACs that do not have a solid business behind them.  Maybe they’d like to invest in blockchain technology. Perhaps they would like to invest in the cannabis sector. Still, they tie up billions of dollars on the sidelines.  Eighty-three billion in 2020 compared to just 13 billion the year before.

Investors are gambling on a less than sure future during a precarious present.  While this may not be an ominous indicator of future dark clouds, and these SPACs are required to be Sarbanes-Oxley compliant, they tie up billions of dollars, lack clear business purpose, and are susceptible to abuse.  There also no guarantee that the politics between countries won’t undo their intended business dealings.  SPACs are a similar type of speculative frenzy as we saw in the dot com bubble’s final days.

The Buffett Indicator

Warren Buffett’s valuation metric represents the total U.S. stock market value compared to annual gross domestic product.  The current ratio is a market value of 42 trillion to a GDP of 21 trillion.  Omaha’s Oracle said that the unprecedented highs preceding the dot-com bubble’s burst should have been an indicator.  To put this in perspective, the Buffett Indicator preceding the Dot-Com Bubble popping was 159%.  Our current number is riding a high of 195%.  Buffet warns that anything close to 200% as we are now is fastening your seatbelt territory.  Valuation is far out of whack from actual production.  Like the SPACs, this indicates a valuation that isn’t true to actual hard economic production.  It’s possibly more bubble-frenzy investing.

Economic Redlining

Even before the pandemic slowed down the actual economy, the Fed’s quantitative easing, lowering interest rates, and heavy borrowing were pumping adrenaline into the economy.  The Fed was using every tool at its disposal to open every valve of the economy.  Quantitative easing is a monetary policy whereby a central bank purchases at-scale government bonds or other financial assets to inject money into the economy to expand economic activity.  Quantitative easing has been largely undertaken by all major central banks worldwide following the global financial crisis of 2007–08 and definitely at a much higher level in response to the COVID-19 pandemic. 

This has revved the economic engine, but when the pandemic hit and the economy slowed, they couldn’t close off of any of those valves for fear of doing real damage.  In fact, they were forced to inject even more money into the economy.  So, we continue to borrow from Peter to pay Paul, as they say.  Our GDP isn’t keeping pace, so we are borrowing money we don’t have in hopes of continued and even growing production.  Just like an engine can’t run in the red forever, neither can our economy charge ahead full steam with no method of pumping the brakes.

Sickness & the Economy

We are now a full year into a global pandemic.  While the unemployment rate has fallen off of its tremendous highs, things are far from going back to normal.  Many have had to adjust their lifestyles, work, and spending to accommodate the new normal.  Even though consumer spending– a natural catalyst for economic health– is projected to increase over last year’s purse-clutching uncertainties, people’s spending priorities have shifted.  Personal savings have increased.  Household indebtedness has decreased slightly.  The recent economic tools being deployed by the government are an extension of the moratorium on foreclosures and evictions, suspension of student loan payments, and a possible additional round of stimulus checks.  If an increase to the federal minimum wage also occurs, the new tool to stoke the economy will be consumer spending.

Though projected to increase and bolster the economy, consumer spending may not break any records, as people shift priorities, refocus on essentials, and still approach their spending with tremendous caution.  With more people working from home, buying a second car and long commutes to the office may be a thing of the past.  This slows spending.  As the vaccinations increase, travel, leisure, and public events will increase, but will it be enough to rally back to pre-pandemic levels?  Probably not this year.  So, spending will remain slow.  While stimulus checks and a hike in the federal minimum wage will have some stimulative effect on the economy, if the first round of checks were any indicator, savings will go up, and consumer debt will drop slightly.  While those are great household economic choices, they don’t precisely stoke the nation’s economy.

Much will depend on the political wrangling in Washington D.C. and what deals and bargains can be struck.  We do know that Yellen’s policies will be different from Mnuchin’s.  While Mnuchin oversaw the distribution of billions to businesses, non-profits, churches, and individual taxpayers, Yellen has already indicated support for helping the consumer.  She stated back in January, “Neither the President-elect nor I propose this relief package without an appreciation for the country’s debt burden. But right now, with interest rates at historic lows, the smartest thing we can do is act big.” Critical in that statement is that she now lacks the tool of rolling back interest rates further, and she is well aware that any move will add trillions to our national debt.  She will portray her job as having two mandates: helping people to stay afloat until the pandemic is over and rebuilding the economy so that Americans can better compete in a globalized world.  

She will also expand regulation and has called for a new Dodd-Frank.  That will scare investors and slow or even force a backtrack of the gains realized in the stock market.  While that may slightly impact your 401k, as I have pointed out before, the majority of Americans don’t own stock, but the stock market drives the economy.  Only 51% of Americans own stocks, and most of those stocks are in retirement plans or 401ks. These plans are mostly stagnant in the market.  They don’t move much.  They are not the quick sales and purchases of options, day traders, or hedge fund managers.  While panic selling can still occur, typically, this isn’t panic selling by fund managers, so it is definitely not part of the average American’s stock market activity.

As an indicator of an economy’s health, the Dow Jones Industrial Average, the NASDAQ, or any market index based on stock, isn’t really a suitable temperature of the economy’s overall health.  So while markets remain up, despite the apparent gloomy news, we could still be hurtling towards a collapse.  Will gambling on taxpayers’ spending work?  Will it stimulate the economy enough?  Will it justify the highs of the stock market?  Will we return to a new normal and be able to put this pandemic behind us?  That’s a lot of questions that all have to have positive answers to positively influence the economy.

Volatility

The markets still have massive volatility, at least according to the CBOE VIX Index.  The index averaged nearly 30 last year, compared to about 25 at the dot-com bubble height. The VIX is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility. Derived from the S&P 500 index options’ price inputs, it provides a measure of market risk and investors’ sentiments. You may have heard of it by its other names like the “Fear Gauge” or the “Fear Index.”

When it is this high, it means that investors are scared.  Their uncertainty outweighs their confidence.  Their likelihood of pulling out of the market in an exodus to precious metals or bonds is much higher, and this is like wholesale banking on the economy doing poorly.  As more and more investors flee the market, it starts a freefall of panicked selloffs.  This can be countered by an entire horde of others buying in cheap, so the market appears to be spasming.

In short, you don’t want fearful investors, so a healthy economy needs the fear factor to be very low and investor confidence very high.

Unknown Impact of Cryptocurrencies

The biggest unknown in the economy right now is the rise of cryptocurrency.  The crypto market is like the wild west.  With thousands of alt-coin cryptocurrencies available, some with highly specialized functions, and some with no real intrinsic value at all (dogecoin, we’re looking at you), national banks have had a hard time pumping the breaks on the market.  Just the nine most common cryptocurrencies of the thousands account for over one million transactions per day.  In two years, cryptocurrency has grown from a market capitalization of 67 billion to over 1.4 trillion for the top 200 cryptocurrencies.  To put this in context, there are only 1.2 trillion U.S. dollars in circulation right now.  Bitcoin alone is at a market cap of 906 billion, equivalent to three-quarters of all the dollars in circulation right now.  It’s time to talk about cryptocurrency as the threat to global economic stability that it potentially is.  

In the last year, Bitcoin has gone from just under six-thousand dollars to almost fifty-thousand dollars, and some project it to double or even triple by year’s end from current levels.  There are massive movements of wealth from institutions occurring in cryptocurrency, increasing exponentially every month.  It also makes the potential for a mass exodus away from fiat currencies and traditional investing methods like the purchase of stocks, options, futures, and commodities.

Suppose consumers lose confidence in one nation’s stock markets and exchanges. In that case, it is possible to rapidly convert currency into cryptocurrency, move it to another global currency, or keep it from the markets altogether.  It’s already happening in some countries where their fiat currencies are faltering.  Their population is converting over to Bitcoin and making purchases with it instead of their nation’s money as it is more reliable.

When it is realized even partially, though, the stock market will suffer.  Banking will suffer.  Economies will suddenly leap up to a global level and away from national controls.  This will cause a backlash by national banks to gain control over the wild fluctuations.  But as history has taught us where countries like Pakistan and India have tried to ban the use of Bitcoin, instead it has caused the use of Bitcoin to flourish.  As people take their financial future into their own hands and away from the Central Banks that run their country, it may result in problems for the markets.  Time will tell.

Economic Inequalities

Another sign of a possible financial meltdown is the continued problem of income inequality in the U.S.  This has been a problem for many decades already, but the income inequality gap has increased since 1970.  An analysis by the Brooklyn Institute showed that this wealth gap is wider now than at the start of the century.  According to a paper by the Federal Reserve Bank of San Francisco, growing income inequality is a good predictor of an impending financial crisis. The report demonstrated that “years of rising income inequality and persistently low productivity growth also sow the seeds for a crisis.” Recessions tend to be more severe and recovery slower if there are significant income inequalities.

In fact, a 2019 article from the Washington Post mentions that the wealth concentration is once again returning to levels last seen during the Roaring Twenties, which preceded the Great Depression.  While the wealthy can flee one national economy for another, the average person is stuck within the economy.  Over the last decade, many wealthy individuals have become super-wealthy individuals.  Many middle-class workers have, at best, held their own; and, at worst, suffered significant declines in their liquid assets and spending power.

Margin to Debt Ratio

Returning specifically back to Wall Street, the margin debt to cash or the gap between options and actual cash balances is exploding.  Thanks in part to low rates, margin debt balances hit an all-time high of $778 billion—nearly 37 times the $21 billion investors held in March 2000.  To look at this another way, customer accounts are currently 72% more debt than cash.  They are betting money that they don’t have, and in many cases, they are losing big.

Margin debt is what drove up GameStop’s stock price, so that should give you an idea of how impactful it can be on current markets.  It can infuse massive volatility into the markets and force government bailouts of investment firms and banks deemed “too big to fail.”  Those investment firms and hedge fund managers are the very same ones who control most Americans’ retirement accounts.  If the margin investor fails and the firm suffers, that pain gets translated to the customers and the economy as a whole.

Rogue Investors

Generally, the herd of investors has been followers and not leaders.  They jump on trends they see emerging from the big whales of Wall Street and hope to make a little money along with them.  That all changed this year with the Game Stop investors from a Reddit board called WallStreetBets.  Noting that several significant hedge funds sought to short stocks like GameStop and AMC theaters, they bought up shares.  This drove up the price markedly.  When those short sell orders came due, they cost hedge fund managers billions of dollars.

Here the little guy wins one, right?  Yes and no.  The little guy won, that is for sure, but the primary driving mechanism of the vibrant stock market has been these large whales that were, in a sense, manipulating the market in their own ways.  So, you have the potential for even more future disruption in the markets.  While regulators and investment firms quickly moved to stop announcing their intended short sales to non-clients, and the investing platforms halted trading to guarantee the hedge fund managers losses were not too great, and investigations were launched, a collective herd demonstrated its ability to dramatically determine the direction of the market.

Traditional and accepted market methodologies will continue to be challenged by an increasingly organized group of organized online investors.  This could lead to wild fluctuations in stock or crypto markets as rogue investors or “populous-collective investors” flip traditional investing methodologies and outcomes on their heads.

Foreign Interference

There are more than just a few countries that would like nothing better than to see the dollar’s status as the world’s reserve currency lose its place and topple.  China, for example, could launch a cryptocurrency tied to the Yuan.  But even without these overt assaults on our market stability, continued hacks of our infrastructure could result in a dramatic collapse in our financial infrastructure.

Cyber-attacks directly or indirectly affect companies, institutions, and organizations economically and cause significant financial losses.  The full impact of the mega-breach SolarWinds hack revealed at the beginning of this year may not yet be realized.  Each attack on our infrastructure results in dollars being spent to repair and harden systems.  That increases debt and decreases investing.

Cyberattacks have become so massive and commonplace in recent years that a genuine threat to the financial systems is more plausible by the day.  As secure as we would like to think the systems running the numbers and tallying the transactions are, they have been attacked before.  Since day-to-day financial operations have moved online, Wall Streeters have grown increasingly concerned about their data safety. While most hacks are for gathering information and espionage, one well-executed cyberattack could bring down the financial system’s entire structure.  NASDAQ’s central servers were infected with Malware in 2010. The sophistication of cyber-attacks and state-sponsored cyber-attacks today would make those attacks of a decade ago look like child’s play.  

A collapse in the markets may not be the result of clever market manipulation.  It might come in the form of an overt attack on the fiscal infrastructure.

Conclusion

This blog examined a few key indicators that parallel the crash of two-thousand and other natural threats to the stock market we face in 2021.  You may not hold a single share of any stock, but the health of our stock market does impact you in genuine ways.  Our critical infrastructure and food supply chains are all tied to a vibrant economy.  When the economy fails, all systems suffer, and declines can be felt everywhere.

The second blog I’ll release shortly will look at practical things you can do today to insulate yourself and protect yourself from a crash.  The three-part series’s final video will look at why a crash may not be imminent to provide you with a 360-degree view of the threat and what you can do about it.  

Do you agree with the indicators I have highlighted here? 

As always, stay safe out there.