Are You Prepared for the Coming Stock Market Crash?

by Bill Bonner

Excess Liquidity The Dow rose 74 points on Tuesday. Gold dropped $3 an ounce. What do you expect? Tuesday was April Fools’ Day. This should be a good quarter for stocks, according to economist Richard Duncan. He believes “excess liquidity” – cash and credit in excess of what borrowers and spenders actually need – drives asset prices. We haven’t been able to connect every tarsal, hallux and tibia of Duncan’s theory. But the skeleton, as he presents it, is serviceable … even attractive. The more excess liquidity, the more people use it to bid up asset prices. As excess liquidity goes down, so do asset prices – particularly stocks. A Change in Outlook Duncan expects the coming quarter to produce a record of excess liquidity. The Fed is still pumping liquidity into the market at the rate of $65 billion every month. Meanwhile, it is tax time, so the government’s needs for borrowing will be relatively low. And according to Duncan, the difference between the available liquidity and the need for it in the regular economy has to go somewhere. But after this quarter, the outlook changes. The Fed is scheduled to wind down QE by the end of the year. And the federal government’s rosy budget scenario will begin to fade – meaning more government borrowing. That means the third quarter is expected to produce only a slightly positive excess of liquidity. And in the fourth quarter, says Duncan, the excess turns into a shortage. If the Fed persists in its plans to taper QE, in other words, the third quarter will likely see a sell-off in the US stock market. This will give the Fed’s forward guidance a kick in the rearward quarters. Instead of continuing to taper, the Fed will panic. Its entire theory of life… its philosophy… and its sacred religion will be challenged. In its view, credit, prices and stocks must ALWAYS go up. Mission Creep There was a time when the Fed was merely charged with making sure the value of the nation’s money was stable. It failed miserably. So it was rewarded with more responsibility. Its mission creeped toward making sure the nation had full employment. At that, too, it fails regularly. So, now it has taken upon itself (Congress never authorized it) to hold interest rates down and push consumer prices up. Actual consumers prefer lower, not higher, prices. But such is the hubris of central bankers that they are willing to contradict 100 million households. They insist on dollar earners and savers losing about 2% a year of their buying power. As we have been saying, it is an odd recovery that leaves the average American with less income than he had before it began. But it is an odd recovery that we have. Stock prices – not to mention prices for antique guitars and gaudy modern “art” – have soared. Incomes, meanwhile, have limped downward. This leaves the typical American feeling richer… but with less money in the bank. Here Comes QE 4 At $81 trillion, total US household wealth has never been higher. But it is supported by precious little household income. Duncan tells us the ratio of household disposable income to household wealth is important. That’s because wealth must be supported by income … or it disappears. This is exactly what happened – twice – in the last 15 years. From 1952 until the 1990s, the ratio of household wealth to disposable income was fairly stable – at about 525%. Then it rose above 600% – on two occasions. At the end of the 1990s, before the dot-com crash. And in 2006-07, before the global financial crisis. Today, once again, the ratio is above 600% – for only the third time in history. And once again, we should be prepared for a crash – or at least a substantial bear market – in US stocks. That will probably happen in the third or fourth quarter of this year. And it will probably be followed by an announcement by the Fed that, instead of taking QE off the table, it will continue the program. And instead of allowing short-term rats to rise six months after QE ends, as Janet Yellen suggested in her recent post-FOMC press conference blooper, the target rate will stay at zero for this year … and all of 2015, too. Duncan believes “QE 4″ will produce the same results as QE 1, 2 and 3: It will send stocks flying again. If so, we could be looking at another big run-up in the stock market … after, of course, a substantial decline. Our advice: Get out of the US stock market now. This market is manipulated, overpriced and dangerous.

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