‘This Is 1929’: Hedge Fund Bear Warns of Great Depression-Style Stock Market Crash

Forget 2008. Hedge fund bear Kevin Smith says this stock market crash will mimic the 1929 downturn that ushered in the Great Depression.
Posted in: MarketsOpinion
March 8, 2020 10:00 AM UTC
  • Hedge fund bear Kevin Smith says that the coronavirus outbreak has triggered a stock market crash.
  • But forget 2008, Smith says this one could mirror the 1929 downturn that accompanied the Great Depression.
  • His firm, Crescat Capital, is hedging against the crash with its three-pronged “macro trade of the century.”

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.

The stock market has plunged over the past month. But Crescat Capital believes the downturn has only just begun. | Source: Yahoo Finance

Hedge Fund: This Stock Market Crash Will Echo 1929

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.

Central Bank Rate Cuts Mirror Previous Stock Market Crashes

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.

The Federal Reserve and Bank of Canada both cut interest rates by 50 basis points this week. The last seven times that happened, the stock market crashed harder in the aftermath. | Source: Crescat Capital via Twitter

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.

Forget PE – This Lesser-Known Metric Shows Just How Expensive Stocks Are

“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.

Crescat Capital’s Smith believes EV/sales is a far more appropriate way to value the stock market in today’s investing climate. | Source: Investopedia

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.

Source: Twitter

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.

Coronavirus Is China’s Chernobyl – And It Will Ignite a Global Economic Pandemic

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.

Smith wrote last month:

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.

The Dow Jones Industrial Average (DJIA) crashed 89% as the Great Depression seized the U.S. economy. | Source: Mmakki/Wikimedia Commons

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.

Hedge Fund Touts ‘Macro Trade of the Century’

Crescat believes its “macro trade of the century” will help it profit from the stock market crash it claims is looming. | Source: Wikimedia Commons

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

Sam Bourgi edited this article for CCN.com. If you see a breach of our Code of Ethics or Rights and Duties of the Editor or find a factual, spelling, or grammar error, please contact us.

Last modified: March 8, 2020 3:20 AM UTC

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Josiah Wilmoth @Y3llowb1ackbird

Josiah is the US Editor at CCN.com, where he focuses on financial markets. His work has also been featured on Yahoo Finance and Investing.com. He lives in rural Virginia. Connect with him on LinkedIn or email him directly at josiah.wilmoth(at)ccn.com.