Home / Opinion / Stock Market Relief Rally Is About To Crash, Warns Prescient Hedge Fund
5 min read

Stock Market Relief Rally Is About To Crash, Warns Prescient Hedge Fund

Last Updated September 23, 2020 1:49 PM
W. E. Messamore
Last Updated September 23, 2020 1:49 PM
    • The stock market has charted a stunning relief rally.
    • But one of the best-performing hedge funds warned in a letter to investors that the rally has topped out. And the bear market has no end in sight.
    • In the short term, quarter one corporate earnings will take the wind out of the rally. In the long term, stocks face a drawn out Great Depression 2.0.

Flush with fiscal and Federal Reserve stimulus, equity bulls have put up a stunning rally. Meanwhile the slowing growth of new coronavirus cases  is brightening the outlook too. In 16 trading days ending last week, the S&P 500 Indexed retraced roughly 50% of its losses since its Feb. 19 all time high level of 3,393.52 .

But in a dismaying Q1 letter to investors, Crescat Capital warns the stock market relief rally has topped out . The award-winning hedge fund’s macro model shows no economic recovery any time soon. And the corporate multiples Crescat uses to assess valuations indicate the stock market is still historically overvalued:

We strongly believe that investors should be wary of getting sucked into the relief rally. Valuations are still historically high for the US stock market at large. Our macro model does not forecast an economic recovery any time soon.

Indeed, the hedge fund’s analysis of corporate multiples in January revealed an imminent end to the record expansion. Crescat predicted a correction just as the market peaked. All eight fundamental indicators raised major red flags for the stock market:

stock market valuations historical extremes
In January U.S. stock market valuations were at historical ultra-extremes across at least eight fundamental measures. | Source: Crescat Capital 

At the end of January, Crescat warned that the median Enterprise Value (EV) to sales ratio for eight of 11 S&P 500 sectors had reached “an insane, euphoric level of 3.6 times, two times than the tech bubble peak.”

ev to sales ratio reveals stock market crash ahead
Percentage of sectors at record valuations. | Source: Crescat Capital

Stock Market Faces Great Depression 2.0

crescat stock market fed rate cut
“This is 1929.” Source: Twitter 

It’s not about COVID-19.

That was merely the catalyst for a stock market correction already in motion. Coronavirus was just the spark that set off a power keg of– according to Crescat’s Q1 letter:

…not only sliding corporate earnings, but historic high equity valuations, record corporate leverage, shrinking global trade, a repo liquidity crisis, and a recent breach of the critical 70% level for US Treasury yield curve inversions.

The hedge fund’s warning bears considerable weight.

The Denver-based global macro asset management company was warning about another major downturn before it was cool. World class economists were warning of another Great Depression by the end of last month.

But Crescat founder and CIO Kevin Smith predicted the stock market crash won’t stop until long after the damage caused by coronavirus and lockdowns has been priced in.

Crescat was even advising investors of a macro global shift and stock market crash over a year ago. After finishing 2018 as one of the best-performing hedge funds  in the world (with 41% returns on its Global Macro Fund), Crescat told investors to flee the stock market. They went as far as to say last March that selling stocks to buy gold would be the “trade of the century. 

After the stock market crashed faster than ever before this spring, gold is now charting seven-year highs . Those who followed the fund’s model have done well amid 2020’s unprecedented stock market crash.

Corporate Earnings Reports Will Crash The Rally

The Crescat model projects the bear market will continue, according to its Q1 letter:

The problem is that the US economy just entered a massive asset bubble bursting recession. The fundamental downturn was in motion even before coronavirus blanketed the country.

As for the timing, they say the relief rally is due to collapse on a wave of dismal corporate earnings reports for the first quarter:

We expect the bear market to fully resume as soon as this week with the Q1 earnings season kicking off with a spate of grim reports. Plunging corporate earnings are not likely to be shrugged off this time.

The bleeding has already begun. Two of the nation’s biggest banks saw their quarter one profits wiped out . America’s largest bank, JPMorgan Chase, said its profits collapsed 69% in the first quarter. Wells Fargo’s profits nearly disappeared with a staggering 89% decline in Q1. Both banks are shoring up for a tidal wave of defaults.

A technical analysis of the stock market’s broad S&P 500 benchmark doesn’t bode well either. The 50% retracement of the February-March stock market crash is a key Fibonacci ratio . That means the S&P 500 rally is battling a line of key resistance just as markets get their first clear look at the damage to corporate earnings since the crash.

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com. The above should not be considered investment advice from CCN.com.