As the coronavirus outbreak rattles the Dow Jones, nervy investors are drawing parallels to the stock market crash that accompanied the 2008 financial crisis.
But one Wall Street bear warns that this equities bubble mirrors an even more terrifying downturn: the Great Depression.
Kevin Smith, the founder and CIO of hedge fund Crescat Capital, believes that unbridled Wall Street speculation has set the maniacal U.S. stock market up for a 1929-level crash.
So while the coronavirus panic might be the initial justification for the drawdown, the roots of the coming crisis go far deeper.
And he wrote this week that the bleeding won’t stop until long after coronavirus’ impact on the global economy has been priced into forecasts:
It really is different this time. Valuations are twice as high as the tech and housing bubble peaks. Investors not looking at median enterprise value to sales have not done their homework. US stocks are in a true mania. They have only just begun to unwind. This is 1929.
Smith was commenting on this tweet from Crescat portfolio manager Tavi Costa, which sounded the alarm on the recent wave of emergency interest rate cuts from the Federal Reserve and Bank of Canada.
Costa noted that the last seven times these two banks cut rates by at least 50 basis points during the same month all fell within either the financial crisis or the stock market crash that popped the tech bubble.
The Bank of Canada and Federal Reserve each executed a 50 basis point cut this week.
“This time is different,” bulls might retort. And Kevin Smith agrees – but for entirely different reasons.
Citing the S&P 500’s median enterprise value to sales ratio (EV/sales), he claims stock market valuations have ballooned twice as high as they swelled during either of the previous two bubbles.
EV/sales provides a more robust picture of a stock’s fundamentals than the better-known price-to-earnings (PE) metric, which simply divides a company’s share price by its earnings per share. While more ubiquities, this ratio fails to account for the impact of corporate debt and stock buybacks, both of which have surged in the decade since the financial crisis.
EV/sales is more complicated to calculate. Add a company’s debt to its market cap, then subtract its cash and cash equivalents. This equates to enterprise value, which you then divide by the company’s annual sales.
The reason EV/sales may be more relevant than PE in today’s investing climate is that a prolonged low interest rate environment spurred a massive spike in corporate debt, which reduces a company’s overall value without directly impacting its market cap.
Even worse, much of this cheap capital has been used to finance stock buybacks, which improve PE ratios without altering a company’s fundamentals. Stock buybacks have been one of the biggest catalysts of the bull market, but they are fading fast, according to Goldman Sachs.
So while PE ratios – though elevated – are nowhere near their historical peaks, the S&P 500’s media EV/sales figure is double what is was in the run-up to either of this millennium’s two major stock market bubbles.
Smith claims investors greedily bid up those valuations because they bought into the narrative that low interest rates and a steady stream of central bank liquidity would guarantee a steady increase in stock prices into the foreseeable future.
That, he says, was the “extraordinary popular delusion of this euphoric market top.” And coronavirus is the pin that pricks the bubble. First in China, and then in stock markets worldwide.
Coronavirus is to China what Lehman was to Madoff; Chernobyl to USSR. The jig is up. The virus will hopefully pass soon, but the fallout from the insane $40 trillion banking and currency Ponzi is the rhino in the room. A highly probable global economic pandemic about to explode.
So what would a 1929-style stock market crash look like?
That bubble popped on “Black Monday,” and in less than a month the Dow Jones had crashed nearly 50%. The index continued to bleed lower over the next three years before it closed at 41.22 – a full 89% below its bull market high.
Even more terrifying is that it took the stock market a staggering 22 years to fully recover.
An 89% drawdown from its current all-time high would plunge the Dow toward 3,250, a low not seen since the early 1990s. Based on this scenario, the index would finally clear the 30,000 milestone right about the time today’s average 40-year-old approaches retirement.
Of course, it’s ridiculous to expect that any stock market crash would necessarily follow a Great Depression-era trajectory, either in scale or duration.
But a run-of-the-mill bear market wouldn’t exactly be a picnic for investors either.
As for Crescat Capital? It claims to have concocted the “macro trade of the century” and aims to reap a windfall whenever the shoe does finally drop. The strategy has three components:
Short the Chinese yuan.
Short U.S. stocks.
Go long on precious metals.
Disclaimer: The opinions in this article do not represent investment or trading advice from CCN.com
Last modified: March 8, 2020 3:20 AM UTC