Ten Reasons for an Imminent Stock Market Crash

Seeking Alpha
1. Insider Selling: An Oversupply of paper

Insiders have been quick to recognize that the market is hungry for paper. Thus, they are selling shares, and issuing debt and/or equity at an alarming rate. Investment bankers, who were very recently idle, now have a backlog of paper ready to go to market which will eventually flood the market and offset the fragile balance of supply and demand.

Why are they doing this? They are cashing out while they can. Nobody understands a business better than its insiders. Irrespective of what the Wall Street “paper pushers” say, if this is the next bull market, insiders would be buying shares, not selling.

2. A Rally Based on Short Covering, Low Volume, and Bankrupt Companies

The rally since the March lows has been relentless and sharp, and one of the primary catalysts for its vicious move up is the combination of low volume with short covering, especially in high beta, low quality stocks. Liquidity is exiting the system, not entering and for some reason, those who are still trading are infatuated with such names as FNM, FRE, WaMu, AIG and Lehman.

These are not the signs of a healthy system rather it is panic buying similar to that of the NASDAQ in 2000 when investors piled into internet stocks based on “page views” given the absence of revenue as a basis for investing. Even rational investors began to question the old business model of revenues minus expenses equals net income. They did not understand why a solid brick and mortar business would not be as “sexy” of a buy as the profitless internet companies. We all know how that turned out.

3. Bullish Sentiment and Market Psychology

At present date, market consensus is short-term bullish and long-term bearish as a result of the aforementioned buying frenzy. Everyone wants to buy the markets and exit before the bubble pops. Guess what? If you want to participate in this bubble—it’s too late. The time to buy the markets was when everyone was bearish, when the WSJ had an article titled “Dow 5000,” and the S&P was at 666. Even if you missed the move from 666 to 800, you could have bought the markets at S&P 800. But with the S&P at 1100, everybody fully invested, and Wall Street shops paper like there is no tomorrow, right now is the time to sell!

Irrespective of factors like momentum and technical indicators, selling is wise because momentum and technical indicators fail to incorporate deteriorating fundamentals in their formula, and therefore have no way of detecting “market moving” bad news. In an environment where fundamentals deteriorate and equities get more and more overvalued on a daily basis, any taste of bad news can crack the momentum. Being bullish in the “short-term” because of momentum is a flawed rationale and soon the last piece of research from bullish technicians will become obsolete. The market has become delusional and is living in fantasyland in the same way people were dancing in the Titanic on the eve before it crashed into an iceberg.

4. Short the USD, Long Everything Else

The market is crowded in one trade—short the dollar and long everything else—a dollar carry trade. For example, you short the dollar and buy Macy’s (M) shares, Gold, Silver, the Brazilian Bovespa, Venezuelan bonds, New Zealand Kiwi, Washington Mutual, Goldman Sachs (GS), you buy anything and you do not discriminate. With the positioning in the market so concentrated, we have the potential for a moral hazard as when the trend reverses, there will be no one on the other side. This is why markets crash!

Correlation is not causality; we can say the same thing by blaming the USD weakness for every market movement. Is everything bad for the buck or is the dollar bad and everything else is good? The short selling inherent in the dollar carry trade puts added pressure on the dollar and reinforces its inverse link with risk appetite. This also implies a substantial rebound in the dollar once stock markets globally sell off because carry traders will need to unwind their bets by buying back the dollars that they shorted.

5. Deteriorating Fundamentals and Rising Income Dispersion

According to a government report earlier this month, household incomes in the US decreased and more Americans were living in poverty in 2008. The poverty rate climbed to 13.2 percent last year from 12.5 percent in 2007. The number of people living in poverty rose to 39.8 million last year, an increase of 2.6 million from 2007.

Yet the paper pushers on Wall Street continue to accord themselves record businesses and record profits. In the same year that the US reported that 39 million people were living in poverty and a record use of food stamps, Goldman Sachs reported record profits. Now if Goldman Sachs were operating a manufacturing facility that employed thousands and they invented the cure to the common cold and now was selling a billion vaccines to China, their “record profits” would be justifiable. But, instead Goldman Sachs is “trading away” after being bailed out by the government with tax payer money and they get to enrich themselves while the rest of the country impoverishes itself.

This is defined by John Williams of shadowstats.com as a rise in income dispersion. A high level of income dispersion indicates heavier income concentrations in the extremes. Conditions surrounding extremes in income variance usually help to fuel financial-market bubbles, followed by financial panics and economic depressions. The poverty report is enough to clearly depict the economy’s deteriorating fundamentals—we need not mention the state of the country’s commercial real estate business or the slow down in shopping or an infinite other number of things that are deteriorating on the micro front.

6. The Chinese Commodities Bubble

The rapid rise in commodity prices is not because China is growing at a very rapid pace together with its BRIC brothers and other emerging nations—it is quite the opposite. China has inundated its market with excess cash, and this cash is being converted to commodities because they would rather hold physical assets than worthless paper money like the US dollar.

This conversion from dollars to commodities is conveying the message that China is growing. However, China’s business model is as broken as that of the US. They depend on a huge export manufacturing base of gadgets that are to be sold to the US consumers using borrowed funds. For China to grow internally and build its own consumption, it will take years/decades not months. So this theory that the Chinese will get the world out of a recession because they are buying commodities is a fallacy, nothing more than that.

As John Horseman points out, the China story is just how large many of her basic industries such as steel and cement have become and just how much excess capacity now exists. To put this into perspective; China has capacity to produce some 660 million tons of steel per annum, more than the EU, Japan, the US and Russia combined with another 60 million tons of capacity currently under construction. She currently produces around 500 million tons, suggesting that idle capacity exists which is equivalent to the total of Korean and Japanese output. China's consumption of steel is already equal on a per capita basis to the EU and higher than the US, raising the question as to just how much higher steel consumption can go. Despite China's efforts to stimulate, Chinese steel companies are racking up large losses. Much of this surplus represents a severe limit on the prospects for growth. The bottom line here is whether the Chinese government’s growth story while global trade is shrinking can prevent the financial markets from derailing.
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