When Will This Stock Market House Of Cards Collapse?

Originally Published October 30, 2017
8:45 AM

The box is empty. The cards are set. For this house of cards, what is the most likely threat? Is it profit taking from the all-time highs of Apple, Google, Microsoft, Amazon, and ETFs? North Korea, Washington D.C., student loans, auto loans, ridiculous housing prices with low supply, record margin debt, terrorism or some other factor?

Even though it sounds like a child's story, big kids (adult investors) should pay attention as well. We are at a very interesting point in this current bull market. Some pundits see it running forever, while others have called for crashes of epic proportions for the last five years. The Bulls echo their sentiment after every minor bump in the road is passed, while the Bears boast every down day as "the beginning" of something. I am one of the bulls now, well kind of. My goal is to always shatter my biases to make better decisions. My goal is to always shatter my biases to make better decisions. I have found temporary proof in my search for lack of doom and gloom for now.

Business Insider recently published a story detailing the lack of cash flowing into the markets. This may or may not support market exhaustion theory whereby further upward movement by volume is waning. While I was skeptical about the truth in it, I began to dig more.

The daily volume in the S&P 500 has been moving down since the "great financial crisis (GFC)", and more so it has been down since the summer of 2015. The chart below displays the S&P 500 and its volume in billions of traded shares per month since January 1998. Vertical dotted lines depict the highs for the index prior to the "dotcom bubble burst" and GFC. This chart does not spell near-term doom for the markets from a trend and pattern analysis point of view. In fact, it could be at least a year or more away.
house of cards

The stock market volume was on the rise prior to the last two "crashes" as shown above. Volume, selling pressure, spiked once folks recognized what was happening in 2008. The dotcom burst did not see any spectacular volume increases.

If the Business Insider article is true, declining monthly volume for the S&P could be explained and may continue. This is one of many areas that should be monitored while looking for a red flag of pending market doom. Concern may not be warranted until the volume surpasses 85-90 billion traded shares per month too.

Another warning sign of future uncertainty can be compiled while considering the Business Insider article along with extreme margin debt levels. Margin debt is basically loaned out money for investors to invest with. A margin call would occur if the financier sees potential for its outstanding loan to be defaulted on. The margin call would force the borrower to pay back its loan in a hurry. A large amount of margin calls would occur in a cascading market collapse. This in turn would lead to potentially catastrophic results for the stock market, investments, retirements, and livelihoods.

An interesting article written by Daniel Moore back in August that discussed NYSE Margin Debt to US Gross Domestic Product (GDP) extremes. Mr. Moore developed a chart which aided in the creation of the chart below. He pointed out that GDP extremes pre-dated stock market drops. I wanted to believe his analysis but there are some holes in it.
Margin Debt to GDP figures are currently at the highest ratio ever. NOTE: GDP figures came out on October 27, 2017 and heralded as a win for the President/government because the annual GDP number increased by 3.1%. The actual number was not disclosed so I manually computed the number from historical GDP figures.

The percent always found in the news is based on the increase or decrease in GDP compared to the same reading at the same time last year. Last October's reading was $18,905 billion. A 3.1% increase from that would equate to a rough reading of $19,491 billion this year. That looks like a positive increase, but the most recent GDP figure from last quarter was $19,495 billion. Even though it is an increase since last year, it is a decrease from last quarter.

house of cards

Like the other chart, vertical dotted lines display the highs in the S&P prior to the "crashes." Mr. Moore's assertion of Margin Debt to GDP peaks preceding S&P declines is valid, however, the peaks end with a steep decline prior to the market crashes. The ratio is currently at a high point, in fact the ratio is 2.87% which is the highest ever. In May 2017 it was 2.85% which lead to nothing.

Fear should not set in until a sharp decline in this ratio is seen such as the one around August 2015. I postulate a decline in this ratio could see the much-anticipated market decline following 3-6 months afterward.

As "well" as the markets have been doing, not all industries are enjoying the same glory. Lack of cash to invest and declining volume show not everyone is invested in the market. I wouldn't be surprised if most of the investors on the sideline are the ones that got burnt the most from the GFC. Most of them were unable to retire or forced to go back to work. I fear those same people may try to finally re-enter the markets now that the pundits are continuously hyping this rally. Insertion this late in a rally like this could be catastrophic. These burnt investors could lose everything once more while hoping to rebuild their fortunes.

Real House Of Cards Is On Capital Hill

Market's do not go up forever. The kryptonite for this market is yet to be discovered but could be on the horizon. A lot of people are too invested in the market right now to pull out and pay higher taxes on their capital gains. Most investors most likely will not sell until 2018 in hopes of a lower tax rate and more money in their pocket.

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The gridlock in D.C. will absolutely determine where the markets go. The recent Budget vote in the House of Representatives saw 20 Republicans vote nay. This was 8 percent of the Republicans. The budget will not be passed if the same percentage of Republicans (they would lose 4 and can only lose 2 if it’s a party-line vote) vote against the bill in the Senate. Without agreeing on this budget, tax talk is only that.

The markets are temporarily calm even though the margin debt levels are incredibly high. The included charts do not signal a near-term drop for the market, but anything can change that in a hurry. I am a cautious investor but would be comfortable investing a little longer.

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DISCLOSURE: We currently do not have any positions in the mentioned stock. We may initiate a position in the next 72 hours. This article is for reference only and should not be solely relied on to predict future movement. Historical movements and technical indicators should never be the sole basis for entering positions involving risk. You should not take a risk without fully understanding the system, market, and having established trading discipline. Make sure appropriate research is conducted prior to taking any risk in a marketplace. The author and Limitless Life Skills LLC do not have a financial relationship with the companies mentioned in this article and all expressed views are that of the author.

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