We are going to see a 1987-style stock market crash (only worse) for sure, and it is only a matter of when.
I have blogged about this many times, but investing guru Mike Green was just on this Julia La Roche podcast – Why A 1987-Style Crash Is Now Almost Inevitable – explaining why.
So, I am hitting it again for two reasons: (1) the podcast is very short – so every investor should listen to it; and (2) I am adding another twist to explain why this threat will lead to higher rates.
Green says that the S&P 500 is as much as 75% over-valued and that it has to come back to reality at some point.
It is so overvalued because of “passive investing” by the huge index funds like Vanguard and BlackRock.
They pour money into stocks no matter what is going on with the underlying companies – and this in turn pushes up stock prices no matter what in an endless self-fulfilling loop – until it reverses.
So much money is pouring into stocks because of the Pension Protection Act of 2006, which made 401(k) contributions automatic UNLESS someone opts OUT. Prior to 2006, people had to opt IN.
Because of this, passive funds now comprise a whopping 55% of the market – up from 2% in 1992. And the markets now operate irrationally in what Green calls a “George Costanza market” (it does the opposite of what you expect).
We seem to be seeing it now, in fact, with high oil prices and the war in Iran. Green, however, gives other interesting examples.
When passive funds comprise 65% to 85% of the market, per Green, we’ll be in crash territory – almost certainly. And – we’re only 2.5 years away from 65%, but it could come sooner.
Once the passive funds start withdrawing, the exact reverse of the run-up will take place – but at a much faster pace (as we saw in 1987).
Influxes of Liquidity/Cash Inflate Stocks
Politicians and the Fed are somewhat aware of this, but they also know that influxes of money/liquidity into the economy end up in 401(k)s, which end up in index funds – which props up the stock market.
See what happened to stocks during COVID, for example, when the Fed and the government were flooding the economy with cash.
So, expect more QE and money printing to keep the stock market elevated at least through the midterm elections. And … that will likely cause inflation, resulting in higher rates.
After the midterms, not so much – as the new Fed Chair (Kevin Warsh) is no fan of money printing or Wall Street – so I do not put it past him to allow for a correction.
And – once the correction comes, rates will fall, as investors will move into bonds.
What should investors do? Hell if I know… I’m just a mortgage guy.
But – I personally might diversify out of stocks. Investors should also listen to the podcast, as it is very provocative and interesting.
