Economist James Dale Davidson — who correctly predicted the collapse of 1999 and 2007 — is once again sounding alarm bells on what he says is an inevitable stock market crash this year.
Davidson has recently published his book, The Age of Deception: Decoding the Truths About the U.S. Economy, has said, “Yes, the stock market is near all-time highs. In fact, it is up 200% since its low in 2009.That is an historic rally. But this rally is coming to an end. The writing is on the wall.”
In a feature on The Sovereign Society website, Davidson enumerated several indicators to back up his stock crash pronouncement. For starters, he pointed out, “Since it is clear that the stock market is going up because so many people are gambling with margin — with debt — when the market starts to pull back, it will be fast. Real fast. As stocks go down, investors will get margin calls and they will be forced to sell their positions immediately…which will accelerate the markets sell-off.”
You can see the above chart to understand what Davidson is talking about with the stock market running up and now….going sideways.
Davidson identified the low stock market participation rate as the next indicator, noting that it’s “at astonishingly low levels for a market selling at such high valuations.”
“You see, after the last crash of 2008, many people have resisted getting back in the market. So essentially, although the market has hit all-time highs, there aren’t a lot of people investing. Never before in history has there been a sustainable market rally on low volume,” Davidson explained.
In a healthy market, the Shiller PE ratio is about 16. Right now, it sits at 27… 1999 and 2007-like numbers pic.twitter.com/Yfqm3HDsrR
— The Capitalist (@Capitalist_Site) May 22, 2016
Next, Davidson highlighted the price-to-earnings (P/E) ratio of the stock market, which is “hitting all-time highs.” The P/E ratio measures the price of the stock versus how long it will take for the stock to be worth that price.
Davidson noted, “In a healthy, normal stock market, the Shiller price to earnings ratio is about 16. That means it will take 16 years for a stock’s earnings to equal its price. But right now, the average stock in the S&P 500 is sitting at a Shiller P/E ratio of 27. That’s nearly 50 percent higher than the normal ratio.”
Davidson further added, “The only other times we have seen the price to earnings ratio this high was in 1999 and 2007. Again, both times this happened, stocks dropped by 50 percent and 55 percent. So we know that we have fewer people trading, but they are using more margin, and they are pushing the PE ratios to dangerous new highs.”
Worst Case Scenario
Davidson has said that he expects the massive collapse that’s “coming very soon” to “blindside most investors.” He disclosed, “To be frank, a 50-percent correction in the stock market is actually a conservative estimate. If the market drops to its 2009 lows, we’ll actually see a 70-percent correction.”
Davidson then uses some staggering percentages to illustrate the worst case scenario: “Real estate will plummet over 40 percent, savings accounts will lose 30 percent of their value, and unemployment will triple,” he said.
There are others who share Davidson’s view. Among them is American business magnate Carl Icahn who — in his guest appearance on CNBC’s Power Lunch last month — said, “I do believe in general that there will be a day of reckoning unless we get fiscal stimulus.”
Icahn cited the Federal Reserve’s decision to maintain low interest rates, which would potentially create “tremendous bubbles.”
For the record, Icahn had already sounded the alarm on the potential stock crash back in 2015. Back then, he expressed his belief that the market is “extremely overheated—especially high-yield bonds.”
Icahn had told CNBC’s Fast Money Halftime Report: “I think the public is walking into a trap again as they did in 2007. I think it’s almost the duty of well-respected investors, like myself I hope, to warn people, to tell people, that really you are making errors.”
In a Profit Confidential article, Jing Pan — a research analyst and editor at Lombardi Financial — explained, “Icahn thinks that a large part of the growth in the real economy we see today comes from the artificially low interest rates. His rationale is that businesses have been getting access to cheap money, and by using that money, they were able to expand their operations; creating jobs and generating revenue. However, once the Federal Reserve raises interest rates, businesses will no longer have access to that cheap money.”
Aside from Icahn, a report in The Sovereign Investor, cited economist Andrew Smithers, who warned, “U.S. stocks are now about 80% overvalued.” The report explained, “Smithers backs up his prediction using a ratio which proves that the only time in history stocks were this risky was 1929 and 1999. And we all know what happened next. Stocks fell by 89 percent and 50 percent, respectively.”
The Sovereign Investor likewise highlighted the fact that “the Royal Bank of Scotland says the markets are flashing stress alerts akin to the 2008 crisis.” the said bank has reportedly told its clients to “sell everything.”
Davidson’s doom-and-gloom pronouncements, which he backed with 20 compelling charts, has definitely gotten everyone’s attention. However, it’s worth looking at it from a different perspective.
In a Motley Fool Funds feature earlier this year, Nate Weisshaar wrote, “Even if Davidson is correct that the market will get clobbered in 2016, it doesn’t mean we should be running for the hills. Keep in mind that during the market collapse caused by the financial crisis, the S&P 500 dropped over 50% between October 2007 and March 2009. Then it almost doubled by the end of 2010.”
Weisshaar explained, “Doom and gloom is a story that sells quite well and has apparently been doing well for Davidson for years (although not so well that he doesn’t need to still sell it).” He then said, “Let’s check back in with Davidson’s prediction in 12 months. I’ve placed a reminder on my calendar for Jan 2, 2017.”