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How Do I Know This Is Not A Crash?

FYI | Oct 31 2018

By Peter Switzer, Switzer Super Report

How do I know this stocks sell off is a buying opportunity and not a crash?

The question you might like to ask me (and it’s one that I’ve been asking myself since last week’s sell off of stocks) is: “How do I know this current correction is not stage one of a crash?”

And a related question is: “How do you know this is another buying opportunity?”

The answer is the same for both and it is: “I don’t!” However, this doesn’t stop me giving it my best shot at working it out. If this stock dumping is the overdue correction I’ve talked about over the past month or two, then to call this a buying opportunity, we need some decent proof/reasons.

Let me run through my strongest reasons for not believing that a crash is coming. A crash would be if US stocks collapsed over 20%, which could be a prelude to a recession that could take stocks even lower. If I can make a convincing case for not panicking about a crash, then we can safely suggest that buying over-beaten up stocks is an opportunity you should not pass up. Right? So here are my reasons:

1.The Citi list of factors that warn whether a crash coming is only four out of 18. The last one I saw before this was only three out of 18 in July, but there hasn’t been enough new scary developments to make those red flags become too numerous. The headline for its latest note was: “Bull Tripping, Not Dying.” The chart below shows how in 2000, before the dotcom crash, the negative signs were 17.5 out of 18. For the GFC, it was 13 out of 18 but now it’s only four out of 18!

2. Goldman Sachs isn’t jumping in the bunker and battening down the hatches for a big stocks storm, with the premier investment bank seeing this shakeout as common. “We see limited further downside,” David Kostin, the firm’s chief U.S. equity strategist, said in a note. “Despite the recent sell-off, equity fundamentals are strong and we remain constructive on the path of the S&P 500,” he added. “Goldman’s year-end price target for the S&P 500 is 2850, which looked somewhat pessimistic when the market was breaking records but now points to 3% upside from Friday’s close, and, perhaps more importantly, conviction that the market drop doesn’t have much further to go.” (CNBC)

Since this was written, the upside has increased. If these guys are right, then that would be a 7.2% gain between now and the end of the year! Of course, if it takes three months for a gain of that size in a market that’s so far into a bull market cycle, it would be pretty damn good.

3. I like this from Barry Schwartz, who is portfolio manager at Baskin Wealth Management in Ontario, Canada, who argued on Bloomberg that we’ve seen 23 drops of the S&P 500 over the past 10 years of 5% or more. However, importantly, bear markets don’t historically show up when the US economy is expanding, earnings growth is as good as it is now, consumer confidence is so strong and interest rates are so low. And this chart is a ripper.

In the history of the S&P 500, the index has only been down 10% or more 4% of the time when the US economy is expanding. The other bars say that when the US economy is expanding like it is now, 87% of the time the S&P 500 index is positive in a calendar year. And 63% of the time the S&P 500 will be up 10% or more in a year and 31% of the time it is up 20% or more!

And even if the S&P 500 doesn’t make it to a 10% gain for the year, there’s a good chance that it will go close, given the economic and earnings story in the States right now. Currently, the S&P 500 is down 3% for year-to-date, so making a 10% gain suggests the Yanks need a 13% bounce and that would only happen if a China deal positively surprised Wall Street.

That said, any notable US market bounce would make me happy and would rule out crash fears and validate my buying opportunity expectations.

4. Volatility is to be expected in a long-running bull market like the US one, but what we have to do is weigh up the pros and cons for believing the bull has some legs. If you’re a nervous Nellie or Ned, then reduce your exposure, but I just can’t believe markets will crash, with growth outlooks for the USA and Europe looking so strong. I think question marks over Europe’s growth are not helping right now, but if these concerns prove overblown, then this correction will not morph into a crash. Market corrections without a recession scenario hovering have tended to be a buying opportunity. The Economist Intelligence Unit and Goldman Sachs think 2020 is the most likely time for a US recession.

5. A big driver of this current negativity is the expectations around the Fed and how quickly they will raise interest rates. Remember, President Trump ripped into the Fed boss, Jerome Powell when this stocks sell-off kicked off. We saw a stock dumping in 2016, when rate-rising fear gripped Wall Street, but Ed Yardeni of Yardeni Research, who is a legend of US economic analysis and commentary, thinks inflation is not going to get out of control, so the Fed will not be raising rates too quickly. He says the forward P/E for the US stock market is around 15, and with retail expected to boom over the holiday season he expects a late year rally. Let’s hope he’s on the money.

I know I’m more biased when I talk about a falling stock market creating a buying opportunity, but I am in pretty good company right now. 

Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.

Content included in this article is not by association the view of FNArena (see our disclaimer).

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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