Short and Sweet
How to spot a bubble
‘Amount of leverage in U.S. equity markets now easily the highest in history.’
Cartoon courtesy of MichaelPRamirez.com
“If you want my opinion,” writes Hussman Fund’s John P. Hussman in a recent analysis, “I suspect that a near-vertical market plunge on the order of 25-35% is coming, probably quite shortly, most likely out of the blue, as in 1987, driven by nothing more than the sudden concerted effort of overextended investors to sell, and the need for a large price adjustment in order to induce scarce buyers to take the other side. As usual, no forecasts are necessary. … This dysfunctional behavior isn’t about any particular video game retailer. I suspect it’s actually about some sort of fragility or segmentation in order-flow mechanisms, possibly coupled with poorly managed derivatives exposure. As I used to teach my students, show me a financial debacle, and I’ll show you someone who had a leveraged, mismatched position that they were suddenly forced to close into an illiquid market. Though my concerns run far beyond the amount of leverage in the system, it isn’t helpful that the amount of leverage in the U.S. equity markets is now easily the highest in history.”
These days spotting the bubble is about as difficult as finding it in the Ramirez cartoon above. Hussman attacks Wall Street’s new rationalization of buying into the bubble, i.e., extreme valuations are justified by low interest rates. Those who are all-in for fear of missing out – blindly walking on air – are obviously the most vulnerable. When investing becomes a matter of faith, that faith will be tested. A solid diversification, we will add, would blunt the downside. Though investor margin debt is small compared to the leverage funds and institutions deploy in the market, it does serve as a bellwether for analysts looking for what might trigger a market crash. SentimenTrader’s Jason Goepfert recently posted a warning to his readers that at $831 billion, we are fast approaching a “year-over-year growth rate in [margin] debt – on both an absolute scale and relative to the change in stock prices – will compare with some of the most egregious extremes in 90 years.”
Are you worried about the egregious extremes in the stock market?
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