Like clockwork, every time the American stock market makes new highs, some people insist it cannot go higher. A subset of those believe the market will crash. Others even believe it will reset like it did when the S&P 500 dropped from more than 1,500 in October 2007 to just above 600 in March 2009. A review of the most widely held beliefs about why a new crash is coming shows that some are bogus, while others almost certainly are likely to be right.
Here are the top ten:
1. The S&P 500 price-to-earnings (PE) ratio is too high. Right now, it stands at almost 20. Market expert Mark Hulbert recently made the point that:
… according to data compiled by Yale University finance professor Robert Shiller. The average P/E for the S&P 500 since 1871 is 15.5 and the median P/E is 14.5.
Much analysis based on ancient history has the disadvantage of being old. Earnings have been measured differently over time, and accounting for earnings has evolved. The “S&P is too high” argument can be thrown out. Earnings definitions change too rapidly, as do the ways that public companies report them.
2. The economic recovery has slowed. Well, the recovery has been slow since the recession. If a weak gross domestic product (GDP), a poor housing market and historically high unemployment undermine the market, the S&P should not have moved from its recent low of just over 600 to its current level just shy of 1,700. This is another poorly reasoned argument, if only based on a short period of activity.
3. Forward earnings forecasts are weak. This is a strong argument. Many of America’s biggest companies anticipate poor fourth-quarter numbers, which could extend into 2014. Among the causes are a recession-plagued European economy, which is essential to the revenue of many multinationals. American consumers may have lost the bit of optimism they have had as the recovery barely bounces along the floor without a powerful recovery. Corporations dependent on consumer sales may have trouble posting improved numbers.
4. The federal government could be shut down for weeks or even months. This is another powerful position. Federal spending is a significant part of GDP. The United States employs too many people for a drop in their purchasing power to be shrugged off. If Washington is shuttered, many federal workers will drop off the payroll. So, the average citizen has reason to be anxious. If America cannot keep its own government operating, well, America cannot keep its own government operating.
5. There will be a new recession. That is not really likely, even if the government shuts down for a time. Unemployment, even if it is high by historic standards, continues to shrink toward less than 7%. Housing has recovered enough so the market in home sales is brisk. The number of underwater mortgages continues to disappear quickly, which leaves more and more people with positive home equity. That equity, in turn, in the past at least, has helped consumer spending.