Stock Market Crash Could Be Just Around the Corner
The stock market is roaring at the moment, and we could very well see a “melt-up” in the months ahead. But after that, things could get very ugly. Don’t rule out a stock market crash just yet.
The next big stock sell-off could be much worse than the last one in 2022. For now, though, the stock market could go higher. Take a look at the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) chart below.
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The VIX is often referred to as the “fear index.” When the VIX is trading below 20, it’s a sign that investors are becoming optimistic and that they’re happy to own stocks.
The VIX is currently around 14.7, which is its lowest level since 2021. This signals that the stock market could jump.
Chart courtesy of StockCharts.com
Moreover, the S&P 500, which is a key stock index, is flying high at the moment, as the below chart shows. Chart analysis suggests it could go even higher.
The S&P 500 has escaped the bear market that began in 2022. That bearish trend has been broken. The S&P 500 is now trading above its 50-week and 200-week moving averages. This says the index’s intermediate-term trend is pointing upward.
Furthermore, the S&P 500 broke above the 4,200 level, which was considered a very strong resistance level.
Chart courtesy of StockCharts.com
Why Have a Cautious Outlook About Stocks?
Looking at the stock market from a contrarian perspective, the VIX tumbling the way it has been recently is worrisome. The lower the VIX goes below 20, the higher the complacency and euphoria is among stock traders.
Just before any stock market crash in the past, there was significant complacency among investors, and their euphoria made them irrational. This is happening now.
Keep in mind that earnings expectations are what drive stock prices up or down.
Right now, earnings expectations aren’t that rosy, to say the least. As of June 1, about 78% of S&P 500 companies had reported their first-quarter financial results. Overall, the S&P 500 reported a decline of 2.1% in first-quarter earnings per share (EPS). This marked the second consecutive quarter for which the S&P 500 reported a decline in earnings. (Source: “Earnings Insight,” FactSet, June 1, 2023.)
Over the past few months, earnings expectations have gotten worse.
For the second quarter, analysts are expecting S&P 500 companies to report an earnings decline of 6.4%. For the third quarter, analysts expect earnings growth of 0.9%. Usually, however, analysts end up revising their estimates lower as more data becomes available.
Don’t stop there. It’s also important to look beyond the headlines and pay attention to data that matters to earnings.
According to public and private data, lending conditions are tight for consumers, businesses, and real estate developers. As the Federal Reserve was raising interest rates, the amount of lending wasn’t that high. Moreover, after some recent bank failures, the conditions got worse. (Source: “Where Is the U.S. Economy Headed? Follow the Money,” Wall Street Journal, May 31, 2023.)
Why does this matter? Over the past few decades, banks’ willingness to lend money has been correlated to the strength of the economy. If the economy slows, could business loans become more available and earnings get better? Very unlikely.
Lastly, consumers are in very bad financial shape these days.
Consumer sentiment and consumer spending behavior matter a lot to the economy and stock market. If consumers are pessimistic and not shopping, it creates a lot of economic problems.
There’s a reason why, during the financial crisis of 2008–2009, President George W. Bush—and then President Barack Obama—had to repeatedly talk to Americans and boost their confidence. During the COVID-19 pandemic, we saw something similar.
As it stands, American consumers are pessimistic, and they’ve been pulling back on their spending. That’s bad news for the economy and, ultimately, stock investors.
Is It All an Illusion? 20–30% Downside Could Be Ahead
Dear reader, over the past few months, if you look closely, you’ll find that the key stock indices are being dragged higher by just a few companies. That creates an illusion that all is well, when it’s not.
Take a look at the chart below; it plots the percentage of S&P 500 stocks trading above their 200-day moving averages. The 200-day moving average is an indicator of a long-term trend. If stock prices are above that level, it’s an indicator that the long-term stock market trend is pointing upward.
See something odd in the chart? Just a little over 50% of S&P 500 stocks are trading above their 200-day moving averages. This is well below what it was back in February.
Chart courtesy of StockCharts.com
I will end with this: the risk of a stock market crash is as high as it was a few months ago.
At the moment, irrationality prevails, coupled with complacency. This could cause the market to go higher, but when common sense returns, the downside could be severe. Don’t be shocked if the stock market crashes by 20–30% very quickly.
