Bull markets in stocks seem unstoppable right up until the moment they stop. Then comes a rapid crash and burn phase. Is there ever any warning that a collapse is about to happen? Of course there is.
Analysts warn about it all the time and provide mountains of data and historical evidence to back up their analysis. The problem is that everyone ignores them! You can talk about the dangers represented by CAPE ratios, margin levels, computerized trading, persistent low volatility, and complacency all you want, but nothing seems to slow down this bull market.
Yet, there is one thing that can stop a bull market in its tracks, and that’s corporate earnings. The simplest form of stock market valuation is to project earnings, apply a multiple, and voilà, you have a valuation. Multiples are already near record highs, so there’s not much room for expansion there. The only variable left is projected earnings and that’s where Wall Street analysts are having a field day ramping up stock prices.
Earnings did grow significantly in 2017 on a year-over-year basis, but that’s mainly because earnings were weak in 2016 so the year-over-year growth was relatively easy. Now comes the hard part. How do you expand earnings again in 2018 when 2017 was such a strong year?
Wall Street just uses a simple extrapolation and says next year will be like this year only better! But, this article shows there is every reason to doubt that extrapolation. Earnings are likely to fall short of expectations, which can lead to a correction. Once that happens, multiples can shrink as well. Soon you’re in a full-scale bear market with stock prices down 20% or more.
That’s without even considering a war with North Korea and all of the dangers others have already mentioned. This may be your last clear chance to lighten up on listed equity exposure before the bubble bursts.