Negative Volume And New All-Time Index Highs Make an August Stock Market Crash More Likely
While Wall Street celebrates the booming stock market, a little-talked-about fact is the poor volume propelling it higher. This matters, because it’s more of the drip melt-up as opposed to real buying conviction. Another way of putting it: the algorithmic trading robots are in control, and they will levitate the market until real selling and increasing volatility take place. With an increase in stock prices largely a reflection of valuation extension, the odds of an August stock market crash increase.
Case in point: several recent highs on the S&P 500 occurred on declining volume. There have been at least six such occurrences in the past three months alone. That is, the S&P 500 has made all-time highs on those days where declining volume on the New York Stock Exchange (NYSE) exceeded advancing volume (Source: “A Market Paradox: Unprecedented Cluster Of New All Time Highs On Negative Volume,” Zero Hedge, July 29, 2017.)
While this fact itself isn’t unprecedented, the cluster of six all-time highs on negative volume is the longest on record (double the previous mark). In almost all other cases, the market fell in the months and years following the clusters. Sometimes, the market fell substantially. The signal has been reliable, although market timing, as always, is a bit tricky.
Current Market Conditions Indicating a Possible Flash Crash Similar to 24th August 2015
The next stock market crash could happen in the blink of an eye, if the valuation extension creates a big enough air pocket below. In other words, the market is ripe for a “flash crash” type of event. This has already happened several times over the years, including August 24, 2015, when the S&P 500 opened at 1965.15 and fell to 1867.01 within minutes. Five percent of market capitalization, or about $700.0 billion of wealth evaporated in minutes.
Why could a stock market crash 2017 occur? Because the market is levitating on thin air. The S&P 500 is already trading at the second-most expensive level in history—according to some popular metrics like the cyclically adjusted price-to-earnings (CAPE) ratio—in an environment where stock earnings are barely moving forward. Without the foundation of expanding earnings growth, the moribund volume at new highs is a definite red flag. Keep in mind, the current business expansion has most likely peaked already, and the much-anticipated Trump tax relief looks like a pipe dream.
When the algorithmic trading programs that dominate the market decide to sell, the whole bid could evaporate. The thing is, no one is sure what will trigger these programs to go into reverse. Will it be a valuation threshold that’s a bridge too far? Will it be a terrible economic number reported before market open (something that signals recession is imminent)? Some sort of geo-political black swan, of which there are plenty?
The fact is, the market melt-up is tantalizing investors, but this historic run in equity prices is unstable. It’s mostly driven by cheap central bank liquidity, stock buybacks, and low-information passive investors forgetting about the past. Each of these factors can and will reverse in due course. In the case of central bank liquidity, it’s already going in reverse. Historically, there’s usually a lag between when the Fed removes the punch bowl to when it starts to manifest in equity prices, but there are always negative consequences to this action.
Now, will there be an August stock market crash? Not necessarily. The negative volume S&P 500 new highs aren’t exactly timing mechanisms. But they give off a definite warning that the rally is close to fading. Exact market timing is a fool’s errand anyway. But in this climate, it’s hard to argue that it isn’t better being defensive than to try and squeeze a few extra percentage points from the market. Think of it as risk/reward skewed towards the downside.
As for stock market crash predictions, I posit it will occur when the recessionary “a-ha” moment occurs. That is, when a GDP or CPI number comes in signaling recession is imminent. This two-to-three percent growth with low unemployment isn’t going to last forever. When it breaks, it will be to the downside. When the market finally realizes the “goldilocks” conditions responsible for the multiyear melt-up in equity prices is over, a prolonged period of selling will commence. Every stock market forecast on Wall Street will get revised sharply lower. The proverbial “wall of worry” will come crashing down in a sea of frantic re-positioning.
Whether an August stock market crash happens is anyone’s guess. But a crash is coming. Smart investors are recognizing the signs and acting accordingly. Taking action a year too early rather than a day too late is good advice. But substitute “year” with “quarter” or “month” and you could be closer to the truth.