High Likelihood of a Market Crash

This past week, the Royal Bank of Scotland credit strategist Bob Janjuah warned of a full-fledged crash in global stock and credit markets.  He anticipates a 300 point drop within the next three months.  Janjuah has a lot of credibility because his warnings of credit troubles last year came to fruition this year. 

The whole setup reminds me a bit of Elaine Garzarelli in 1987.  Garzarelli was a relatively unknown quant analyst and money manager at Shearson Lehman in 1987.  In the weeks before October 19th, she made brief appear on FNN, the precursor to CNBC, saying there was a high likelihood that the market could crash.  That sealed her place in history. 

A lot of other warning signs indicate that the Bank of Scotland isn't that crazy in predicting the unpredictable. 

First, the past month generated an Hindenburg Omen.  The Omen is a measure of internal divergences in the market and is signaled on June 6th.  While the Omen doesn't necessarily mean the market will crash, no crash has ever occurred without a signal in the prior 40 days.  For instance, an Hindenburg Omen signal occurred on September 19th, 1987 about one month before the market collapsed. 

click to enlarge images

  

The market is suffering extreme internal divergences, similar to the NASDAQ and Dow in 2000.  During the final run higher, basically the only stocks going higher were technology and Internet related.  Similarly, right now, the only stocks hitting new highs are commodity and agriculture related.  The banks and financials in particular are showing an unsustainable downside divergence.  The financial stocks have, in fact, already crashed.  While the financials typically move in line with the broader market, they have been leading it lower in the past twelve months.

The market has worked off its oversold conditions from March and January and has built up energy to move lower.  The stochastics have just started rolling over, as have the internal breadth indicators.  Neither is yet at an oversold extreme.  In addition, the Summation Index never made it past the 500 level on the rebound from January and March lows - that indicates the rebound lacked breadth and depth. 

Finally, the Fed and politicians always have some hand in causing market panics.  In 1987, Greenhorn Central Banker Alan Greenspan caused problems when he indicated that the dollar's decline would come to an end because the fundamentals were improving.  Shortly after taking leadership post, Greenspan hiked rates partially to stem the greenback's decline.

Of course, the trade deficit continued to increase and the dollar plunged anew.  That caused a crisis of confidence in the market and contributed to the crash in 1987.  Combined with reckless comments from Secretary of State James Baker, the market was nudged over a cliff.  Similar comments from Ben Bernanke's two weeks ago about raising interest rates to stem the decline in the dollar could cause a similar panic if he follows through with his threats.

So while it's difficult to predict a crash (crashes are by definition 4 standard deviation events and are therefore unpredictable), I think all the elements are in place for one to occur. 

Comments

[bluecat]

This market should have already crashed if the fed and his band of merry men hadn't bailed it out several times. The wall street goons have set everyone up for max pain soon!

[adan]

interesting info, thanks!

[adan]

interesting info, thanks!

[User 30121]

Profound data. Is there any wonder there are those of us who are accumulating gold and silver bullion..meaning taking physical acceptance only..period!

[dunn]

what is Garzarreli position now?

[mms]

So..what's a girl to do? Sell all and wait it out?

[SWRichmond]

mms,

I bailed in October. No regrets. I slept fine over the weekend of March 16th. I beat the rush into Treasury MM funds, and hedge with PM's and miners. The conservative advice I am following is this: "The objective in a crisis is not to make the most but to lose the least." I will use my cash to buy stuff "on the other side."

The scenario I expect is a failed reflation leading to a dollar crisis, and possibly a paper asset crisis. It's not just me that expects this. PM's, oil and grains expect it too.

[Bear StocksReport]

We are having a great time short-selling stocks like SNCR, PPC, NCMI, PACW, TMX, CHDX, CTX, CQB, GM and CLMT in this market. You can also buy inverse ETF's like QID or PSQ.

[Dan B]

This is quite interesting. On one hand, the Omen is a fairly reliable predictor of, if nothing else, a downturn in the market - near a 40% probability. However, we could be observing a fundamental shift out of an S&P index weighted heavily in Financials toward one more permenantly weighted tech and commodity for the intermediate term. If the later is the case, we could easily simply drift sideways in a range for 18 months to 3 years. my guess is that is the case - since the large cap investment banks and the Private Banks are desperately wondering where profits will come from for the next 3-5 years. Remeber, institutions drive the market, and institutional money is betting long term against financials.

[ATHELSTAN]

The real crash coming isn't in the stock market, but the drip, drip, drip downward in housing values. That process is irreversible. Bernanke, Paulson and company were too slow and too late to prevent this inevitable slide into chaos. Republicans have a long history of being too slow. Coming to the banquet or funeral with inappropriate dress and no flowers.
Now investors and the general public sense Bush is out of touch with reality, and McCain is taking the GOP down to defeat in November. What looms in the distance is the Obama Express speeding down the track at an awesome and a terrible pace to Carterville. That is to say the town named for the former president.
Where inflation, high interest rates , "touchy feely", feel good politics , with protectionism added to it, and the prosecution of countless investment bankers and hedge fund managers will lead to financial panic. This means the real plunge comes later and after the elections.

[whidbey]

Why worry about a crash? How about a long term, slow Chinese Water treatment in which inflation deliberately eats us alive while we watch things slip away, oil fumbles around and confuses the hell out of all then goes up forever, employment starts to slip, becomes a roaring race of pink slips. Obama is elected and Congress raises taxes and pass es the cap and trade and you want me to worry over a little crash. WE confront a ruin path. Wake up.!!

[altutone]

200 to 300 points down became a daily event it is not called
crash any more!

[ethelbert]

The next few years will be grim,no matter who is president.The chickens are coming home to roost.As a people,we hate ourselves and have so twisted our most precious values that we now cannot recognise them. We will now reap the whirlwind we have sown.

Could nything be more cathartic and cleansing to our systems.

[User 210751]

Glad I sold first week of May. But I think we will do fine HYHY Hydrogin Hybred Technology, (water to Hydrogin, mix w/gas or diesel, and walah!) 10% to 39% less petro used.

[AAA]

I believe that the smart political move that carry on the geopolitic agenda would prefer a crash in october or after the election. Enough time for short-sellers to get squeeze and trigger a late rally this summer. What's gonna happen next? a not-so-unexpected raise in interest rates in september on top of a world food crisis which will crash the stock market.

My bet is on the table. The game is on.

Now the question is for you guys, do you want to stand on the sideline for the next six months, or do you want to grab that last rally to the summit?

[The RealExpert]

What kind of a useless article is this?? You post a few charts and name drop and you think it gives teh article substance? Maybe it does to the novies reading - the people who have no business in the market, but not to anyone else. Instead of reporting the Scot predicting a "crash of 300pts" you need to get a mind of your own and bust his chops for calling a 300 point decline a collapse. Are you not aware teh market lost 450 pts this week?

Notice when the market sells off the "experts" warn of a crash. Show me guys who told people to sell the market 7 weeks ago when it was 13,100. That is valuable guidance, not some guy who follows the crowd.

Seriously, if you are going to submit a piece, make sure it's worth reading.

[jdlech]

We've managed to spend nearly a trillion dollars outside the country. That is to say, we've managed to take nearly a trillion dollars out of the economy. We have a crumbling infrastructure with bridges and levees already failing. Oil at $130+ per barrel with no end in sight - cheap oil is history. We have ignored the very support structures of our economic strength. Of course there's going to be a reckoning; it's a matter of when, not if.
A crash of 300 pts may seem like a lot today, but we'll look back on it as a drop in the bucket soon enough.

[win]

Hey, "Expert" and jdlech: The RBS analyst and this guy are talking about 300 points on the SPX, not the Dow. That's about 2000-3000 points on the Dow, depending upon which stocks get taken down more. That IS a crash.

Not saying it's going to happen. But there is quite a bit of indecision in the market - in terms of volume indicators as well.

[leojbourne]

If we keep our attention on the fundamentals, all will be well. What are the fundamentals? That any policies we formulate will ensure that the super rich become even richer. Therefore, keep an eye on policies regarding the banks and the oil companies. They will get richer in any political climate. I have yet to see a good analysis of past 10 years of leveraged profits by the banks. The current losses do not strike me as being large enough to offset the cumulative profits of the past. I could be wrong on this, and if anyone has the actual facts, please post them.

[mixter]

Don't worry comrades, Obama and the government will take care of every thing. Your mud hut, shared with all of your relatives, and the semi-warm gruel will make you hate America even more, which is what you "blame America first" idiots want! We will all be able to enjoy the malaise Jimmy Carter promoted.

[User 214563]

Farmer Dave, this is not a bible study, the world is not ending, we are all going to be fine. chill out

[Damn Luckto Live inthe USA]

The Real Expert says, "Maybe it does to the novies (sic) reading - the people who have no business in the market, but not to anyone else".

OK so called "Real Expert", first of all, you may want to learn to spell, or as a minimum, use a spell checker. Second, though I somewhat agree with you that a 300 point drop does not constitute a collapse, it isn't the drops we need to be concerned with but the TRENDS! The effect of a net loss over a given period of time is a cumulative loss for the entire market otherwise known as a DOWNWARD TREND. Admittedly the word collapse may insinuate a single day market crash and may be a bit harsh for the current economic climate, but the reality is we are experiencing a severe decline in our global economic status. Our wages have not gone up commensurate with the cost of a gallon of gas, a gallon of milk, or a loaf of bread. Our government continues to feed us positively skewed BS statistics regarding inflation and unemployment, when in reality inflation over the past decade (or longer) has not only caused our income to effectively decrease against the cost of living, but our global standard of living has decreased as well relative to what we had during the cold war... And nobody seems to be concerned about that.
And by the way, what gives you the authority to dictate who the people are "who have no business in the market"? Last I checked we live in America and as such, I have the right, nay, the obligation to learn about and participate in the economic machinery and principles of my country. If that means I invest and lose, that's on me, but it's still my right to participate in the market. And I don't have to be a "Real Expert" to do it. How does one learn if he doesn't DO?

[FallingKnife]

First, Real Expert certainly busted himself as a "novie," by writing such a foolishly inaccurate statement. I understand the Hindenburg Omen has always accompanied a crash. I would like to know how often the Omen has occurred, thus predicting a crash, and no crash occurred. That would give a bit more meaning to the presence of the Omen.

[sbenard]

I'd like to know more about this Hindenburg Omen. Could someone post more?

[najdorf]

It's shocking that there are still people who think of the DJIA as "the market". Are you living in 1910? Gee, what's more relevant, a list of 30 stocks or a list of the same 30 stocks plus another 470 of the largest companies in the US? Furthermore, given globalization and the diversification of most smart investors beyond their national borders, shouldn't we be looking even beyond the S&P to an international index?

Furthermore, a lot of people seem to think of "the market" as a thing that exists independently from personal buy and sell decisions. The market is the sum of all buy and sell decisions. If you're patting yourself on the back for taking money out of stocks as if you're some sort of unique genius, you don't get it. Billions of dollars are flowing out of stocks; these outflows are the cause of market declines, not a symptom. Anyone can see that this is a less auspicious time to be in stocks for the short term than, say, 1996. However, the problem is that in the long term, no one is any good at timing reentry to the market. Anyone who pulled out entirely last year missed the March-May rally, and will most likely miss the eventual recovery and only reenter stocks when a new bubble is in the process of formation. You might be the type of investor who sells in 1990 and buys in 1999. More probably, you're the type of investor who buys/sells/buys/sells/... based on amateur macroeconomic forecasts, generating transaction fees, short-term capital gains, and market-trailing returns. There's a reason that the so-called experts are wrong about half the time, and it's not that you're an untutored genius who can do better. This stuff isn't predictable. If you're tempted to sell it all, ask yourself "When would Warren Buffett go 100% cash/metals?"

[jamie4419]

Some of the top hedge fund managers also say there will be a crash. I believe there will be too.

It does no good to put your head in the sand and HOPE (the four letter word in investing) that there will be no crash.

[edit5410]

The CFTC not raising margin on oil contracts to 50% from 7%[currently] has gone from irrationality to insanity. Bodman, sec of energy under Bush, reiterated over the weekend speculation was not the cause of the high price of oil. He's either a poor liar or an idiot. Now Samuelson, sec of the treasury under Bush, says speculation is not the cause of high oil prices. He also is either a poor liar or an idiot. Actually, his firm, Goldman Sachs, benefits so much from inflated oil prices, commissions, etc., he really is "smart" for his real master, Wall Street. Witness the subcommittee findings today that futures speculation now comprises 70% of oil trades, up from 30% in 2000. Anyone ever trading commodities, me, Bunker Hunt, et.al, will tell you the CFTC can send oil to $70/ barrel by raising the margin to 25-50%. I have been noting this to the NYT, WSJ, Bill OReilly, Neil Cavuto, etc. and they are just getting around to mentioning the margin issue. Almost laughable was Karl Rove's comments about the hot button word, "liquidity". Raising the margin will reduce the number of speculators, but won't affect liquidity. There are still "puts" and "calls" to inject any liquidity for those speculators wanting to gamble. A recent analysis of China's consumption of oil revealed China's total consumption of oil was equivalent to 1-2% of our daily consumption. We have already reduced our U.S. consumption by 1-2%. So the argument that supply and demand cause the high oil prices is erroneus. Every argument by the benefactors of high oil prices, brokers, investment bankers, oil co.s, pension and hedge funds, etc. that this is where oil should be priced, based on supply and demand, can be broken down. Oil in the futures market is simply an ill-chosen runaway bull market. It could be silver or widgets. Its just paper to 70% of the traders in oil futures. Sadly, it is affecting world-wide economies, our economy and quality of life.
And the people who can do something about it, the CFTC and the Bush administration sit on their hands. RAISE THE MARGIN TO 50%! Corn, wheat, commodities dependent on energy for production will fall. Then we can focus on real problems, e.g. hunger, the World Series, etc. For me, it has become a moral/ethical issue for the Bush administration to leave this country on the brink of stagflation as he leaves office. He will leave that legacy, but then again, he doesn't seem to care.

[Thalamus]

The market will continue to drop, or crash, but it won't return to it's high's again--not for a long time if ever. The dollar's days as a reserve currency are ending and so is america's free lunch--we'll have to actually produce something to keep our dollar valuable now, and do this with massive energy dependence.

[Scorpio69er]

Hyper-inflation is already here on the items that matter most to the majority of people: Gas, food and healthcare. Couple this with a still-long-way-to-go deflation of home values and the drying up of easy credit and you've got a combination punch to the gut of the American consumer-driven economy from which we're not likely to soon recover. The fact that the government still spends like there's no tomorrow as it piles up an ever-increasing deficit seals our fate. "Ugly" doesn't even begin to describe what's in store for us.

[algoa456]

Obama - right face, right name, right experience for the coming American Obama Republic - sorry I meant American Banana Republic. This is how the US goes down, not with a bang but an Obama.

A factor mentioned in passing by one or two postings, but not emphasized, is that the market is perhaps reflecting the growing concern that we will soon have a president named Obama with limited experience, a Chicago leftist agenda and a naive do-good worldview like Carter.

On the global scale gasoline in the US is still cheap at $4 a gallon. Have you traveled to Europe lately and seen the prices there? Oil is only one factor in the decline.

[jpbernarding]

How can people villify Obama, when the so-called pro-business President, Mr. Bush has moved this country from a prosperous nation with a surplus budget to a nation where most citizens are struggling with cost increases in the basics: fuel, food, and healthcare.

Mr. Bush is a not-very, bright, previously rich kid, a business failure, who rose to power on the strength of his Dad's position/connections, a likable personality, and a good sense of humor. But who's laughing now?

We financed a war with money borrowed, largely from China and Japan. We enjoyed an artificial climate of prosperity, the foundation of which was the squandering of home equities, pumped up by bad Fed Reserve policy. What happened to Liberty bonds, rationing coupons, the draft, and other hardships the nation willingly endured during past wars. Oh, that's right, Japan, China, and Germany were not offiering to supply us with cheap goods, and use the profits to finance our wars in 1941. We had to pay for the war ourselves, then! How old-fashioned! Easy credit wars are so much cooler! But, surprise!! Now the bill comes due at the gas pump and the super market.

The Fed discount rate of 2% is absurd in a world of galloping inflation. But if they raise it, financial institutions will fall under the weight of all the ARM-mortgaged properties out there, which will go into foreclosure. Because if these so-called prime mortages, which are adjustable and pegged to prime rate or US financial instruments, start to go under, then the so-called sub-prime crisis will have been just the tip of the iceberg. Our econonmy will dive like the Titanic. So we have to suffer the low interest rates and inflation, as the alternative is catastrophe.

As far as restraining speculation in oil goes, be careful what you wish for, you might just get it. The strong oil market is soaking up a tremendous amount of US dollars, a large portion of which comes from China/Japan/Gemany, and goes into the pockets of the various Arab states, who then recycle the money back into the US ecnonomy, not just by buying US debt, but by financing captial acquisitions, such as the sale of the Penn Turnpike to a Spanish-led venture, and the sale of Anheiser-Busch Belgian interests. It is only this recycling of US money that prevents the collapse of the US dollar, which would otherwise sink like a stone under the wieght of current 2% Fed reserve policy.

Raising interest rates would sink the real estate market under the weight of foreclosed properties, which would sink the banks, making foreigns investors extremely unhappy, and they would sink the markets. Banks lent money to people, who were never qualified to pay it back, and in many cases committed fraud on their loan apps, while the banks turned a blind eye to obvious fraus, in order to make a quick buck on loan fees. Now we all have to pay at the pump for the greed, fraud, and hysteria of some of us.

There is a pressure built up in the system, due to all the egregious errors of the past 7 years. The high price of oil is where the pressure is getting blown off. If Congress could force the price of oil down, the dollar would sink with it. The damage has been done. There are no easy fixes.

[easywriter05]

It's pretty clear to me where this is headed. Short term we may have some market rallies and upturns, perhaps some lasting months or more. But long term the scenario is negative. We've had a bull market as long as most of us can remember, but the worm is turning. We've spent ourselves as a country into a massive debt hole for starters--our society now owes $45 trillion, more than 3 times GDP, about $150,000 per man, woman and child--and it's increasing (not to mention the massive bill coming due for social security, medicare and other entitements; we've pumped an increasing amount of our capital back into non productive enterprises (what sort of return are we getting off the Iraq war?), and thanks to Greenspan, Bush and the Congress, spent the last eight years creating the greatest housing bubble--and bust--in decades. The credit crisis is real and will only get worse. It was a nice long party, but the hangover will be even longer--much longer (sorry for the stupid metaphors). Books like The Collapse of the Dollar, Crash Proof, Bulls Eye Investing and others have outlined these problems, but they're generally dismissed as extremists, even as the talking heads and pied pipers lead us to believe another giant rally is just around the corner. I'm not sure we'll have a currency collapse as bad as Argentina in the 90s, or Wiemar Republic/Germany, but we could be in for some tough times...super inflation, rising unemployment, sluggish growth...you know the story. Better buckle up...

[love it]

Bravo Farmer Dave. Right on

[Ken225]

Markets rarely crash when everyone thinks they will. I can't believe all the negativity Im reading about the market nowdays. To me thats a bullish indicator. Either way, its doesn't matter. One of the keys to making money is to assume the market can crash at anytime and set yourself up so that your risk is minimized if it does crash.

[Lilliana]

The sky is falling,
Dont talk about the market.
All is lost
Stocks loose 20% in one week,
Doom and Gloom Rush for the exits
Overmargined speculators cant stand it
The market is sold out
THEN
Fabulous bargains abound
Fortunes are made
All is sound in the market.
Some even say Social Security should invest in stocks.
Findings
We are at the Doom and Gloom stage now.
We;ve seen it all before.

[pachanguero]

I hate Republicans and Democrats. But Obama scares the hell out of me with his socialist talk.
His wife is a mean, uptight bitch and he smokes two packs a day to cope. The dude looks like a fish out of water. I will hold my nose and vote for McCain.

[CarlosSlim]

"I will hold my nose and vote for McCain."

8 more years of Bush policies, GOP cronies packed into all regulatory positions, a DOJ that looks the other way as felonies are being committed, wiretapping Americans illegally, illegal hiring practices...the list goes on and on.

Yes!

That is the only possible solution!

More of the Same that got us into this mess to begin with!

Now, that's THINKING for yourself!

[lex]

WORLD WAR III here we come!!!!!!!!!!!!!!!

[curious cat]

nevada, i was really worried, for a second there, and then i read about the incredible gas chip that could save me money and increase my mileage. i was wondering what they did with all those vegas casino chips when the rubes stopped flying to vegas. i'm guessing you might also have a magnetic bracelet for my arthitis, huh? thanks for the tips.

[kotika98]

"How to way to make predictions for dummies" guide.

Market down 300 points from the peak? predict a crash!

Banks losing 500 Billion buck? Predict a credit crisis!

Earthquake destroys SF? Predict a long a arduous rebuilding effort!

People dying in Indonesia from chicken flu? Predict a 2 billion people death toll next month!

Biggest rain in 50 years? Predict a Mississippi flood!

(I'm only half joking - some useful conclusions can be gotten this way, too)

[Robertm73]

In 1929 after the first crash, many predicted the bottom had been reached, 1933 was the real bottom by then the stock market was done 80% and most everyone who tried to fish on the way down where burned. Think this time is different. Think this is like 1987? 1973? Look at the major causes of the crash easy credit, real estate speculation and complex ponzi schemes involing compliated financial instrutrements that look like SIV and CDO of today. This is merely the open prelude to next few years. It will take 2-3 years before we know the true cost of the unwinding of past years. You want the future, look at 1929-1933. See who made money and who wanted HOPE to win. Forget hope and hold on it is going to get rough.

[blink0404]

Or not... the end may be closer than we think.
Check out this article- pretty optimistic but some good points.
www.greenfaucet.com/th...

[CreditJockey]

"Janjuah has a lot of credibility because his warnings of credit troubles last year came to fruition this year. "

Janjuah has the credibility of a stopped clock

[plv900sL]

THE SPECIALISTS TAKE THE MARKET UP AND THE SPECIALISTS TAKE IT DOWN, FOLLOW THEM

[JCHermes]

Lilliana (Jun 24 09:22 PM) is about to see something she has never seen before—the reduction of the richest, most powerful nation on Earth to the Third World status of a Banana Republic (a most un-Representative Republic). I am in complete agreement with jpbernarding (Jun 23 11:46 PM), easywriter05 (Jun 24 12:08 AM), RobertM73 (Jun 30 10:29 AM) as to where we are heading. It won't be pretty.

Pachanguero (Jun 24 10:50 PM) rivals George Bush for Village Idiot. Of course, we have been had by both Democrats and Republicans, but it will do no good to hate them. Obama will not be the "cause" of any of our troubles, but he will not be able (whether or not he is ready and willing) to fix it. It doesn't matter what your political/social philosophy is. Greed and rampant speculation have corrupted all our dreams of creating a Utopian Heaven on Earth.