A 50% Stock Market Crash?

On this week’s episode, Karl discusses whether or not a 50% drop in stocks is in the cards?  There are plenty of articles written about the next stock market crash.

Transcription:

Hey guys, welcome to The Eggerss Report, it’s your investing playbook. Thanks for joining me. We always appreciate it. Our telephone number 210-526-0057, 210-526-0057. Our website is eggersscapital.com, E-G-G-E-R-S-S capital.com and we actually have some changes coming to it probably within maybe by next week. We’ll see. I’ll let you know what those are when they come, when we get things finalized on there, and tell you what will be happening on there, and you can give me your feedback.

Anyways, go check out the website as it is right now. They’re not major changes. We made a major change a few years ago, maybe a little over a year ago, and we’ve had a lot of positive feedback on it. But you’re going to find a lot of things on there. We try to make it really simple. Really there’s four main areas. One is to get a free consultation. It could be by phone, by video conference if you’re in another city or state from us, which we do a lot. Or you could come into the office of course. Really what we do is we discuss financial planning with folks, or we discuss investment management. Those are the two main things.

On the website there’s a financial planning button. There’s an investment management button. And then the other thing that we do, the fourth thing is financial education. That essentially is our blog. So when you go there, you’re going to see all the most recent articles, and that page is really going to get a refresh. But all the articles are there, anything we do on public television or anything we do on the radio, it’s all going to be right there, articles we write and so forth. So make sure that you check that out. There are share buttons on there as well. So if you’d like to send it to a friend or what have you, it’s right on there. That’s a little bit about the website.

Well, let’s dive right into this market and what’s going on because we’re … It’s really every week is interesting, and this week one of the days I think was probably I would say, maybe, maybe … I guess it was Monday, it was probably the most interesting day of the year. We’ll get into that in just a minute. Let me give you kind of a quick run down on where the money was made or lost this week.

If you owned grains, which we do, kind of the agricultural commodities, they had a nice bounce this week up over 3%. The REITs also bounced about 3% as well, which is interesting because if you look at what worked this week, consumer staples, REITs, pharmaceuticals, biotech, that is, those strongest areas, that is not telling you at least this week that the economy is going to rip-roar in the future. That is telling you people are getting worried about the economy. Now it’s only one week but it’s a trend. We look at these baskets of stocks to determine kind of what the mood of the market is. So that was something that stood out this week.

On the downside, the things that got hurt, the volatility index, so there was a lot of fear this week, but we did see drops in things like steel, metals and mining, the gold miners, and they weren’t huge but we did see some weakness in those areas. As for the major indices, the Dow Jones was just really flat for the week, S&P up a little under 1%, and the Nasdaq was up a little under 1% as well. Those were kind of your [inaudible 00:04:42], and then of course everything else was in between. But let’s kind of run through the week.

Number one, on Monday we had this really, as I called it probably the most interesting day of the year because we saw value significantly outperform growth in a big way. Now there’s some I guess you could call it debate on what really is considered value, what’s considered growth, but there are plenty of industries that break these two groups of stocks into buckets, fast growing companies versus companies that are slower growing, undervalued. But everybody sees and perceives value differently from one another. But they have these two baskets and we hadn’t seen that type of outperformance of value over growth really since I would say probably around June of 2017, so over a year. We had a big outperformance. I think it was 1.6% that day.

Now remember, this comes off the hills and was partially attributable to the tech sell-off, because what we saw last week was the week before last really was the Facebook and Netflix sell-off. And that caused people to start questioning whether the FAANG trade, Facebook, Amazon, Apple, Netflix, Google trade, F-A-A-N-G was over. We’ve seen a drop now in Netflix of … it’s bounced a little bit, but about 20% from its high. We’ve seen a drop of Facebook about 18.5% but was obviously lower, was about 20. So let’s just call both of them around 20%. We have a big chunk of the FAANG stocks technically what some would call on a bear market. I wouldn’t say they’re in a bear market. But it is an area of concern.

Now if we look at things like Alphabet which is Google it’s only off 4% from its high but still not at its high. If we look at Apple reported great earnings it is at its high and, spoiler alert, Thursday became the first trillion dollar company. Before we go over the rest of the week, Thursday was when Apple became the first trillion dollar company, and we’ll get to that in just a second. But what’s why you’re seeing the value versus growth debate, is the FAANG stocks are really the growth and as they start to slow down potentially, will investors shift into value stocks?

Because remember, the divergence between growth and value based on the few different metrics is as wide as it’s been since the dot-com bubble or the year 2000. That’s a concern. This market is getting more and more bifurcated where the expensive stuff is really expensive and the cheap stuff is getting more and more cheap, and that’s an opportunity for you, but it’s also a warning sign depending on what you own.

Now we also saw Monday that President Trump came out and said they wanted to reduce capital gains taxes in conjunction with kind of their tax cut 2.0. But here’s the deal. They wanted to reduce capital gains taxes not just by saying, “We’re going to lower the rate, or eliminate it,” or whatever. They said, “We’re going to put an inflation adjustment on your cost bases.”

What does that mean? That means if you bought, oh, let’s say Apple stock at $100 per share and it’s now worth $200 per share, and you sell it, you would have a capital gain and your shares have doubled. And you know you paid $100 a share. That never changes. What the Trump administration is proposing is to have that $100 go up. What you paid for go up each year inflation adjusted to make your gain smaller from a tax standpoint.

Now how confusing is that going to be? Terribly confusing because in my experience clients I deal with would have an awful time dealing with capital gains and trying to figure it out, and of course, we do that for our clients as do most brokerage houses now as well thanks to partially Dodd-Frank. That was one good thing about Dodd-Frank is it forced a lot of brokerage houses to put cost basis on the statements and there’s portability to were the cost bases goes from brokerage house to brokerage house. So it’s made our job as advisors much easier because we can see the cost basis as opposed to having to track it down with old paper statements and what not. But even so it still makes it difficult if somebody’s bought it several times or maybe they did it before Dodd-Frank or whatever the case. Imagine having to inflate adjust your cost basis with this way.

This is something that I don’t think will gain any traction, and if it does it will be preposterous that it does that. But I do think that obviously trying to reduce capital gains would be good, and what’s interesting is of course a lot of the bears, a lot of the anti-President folks out there are saying, “Well, you know what? This is just for the rich.” Well, pardon me, but I would think that a lot of middle class have capital gains. Most of our audience is probably considered middle class. Would you not say that about yourself maybe? Do you feel like you’re one of the one percenters? Probably not. So do you have capital gains? Do you have to deal with tax consequences when you sell things? Of course you do. Capital gains reduction and the tax reduction of that would benefit many people drastically. But the way they’re proposing it I don’t agree with and I don’t think that will get any traction.

On Tuesday the strong market got a boost because China said they’re willing to talk once again on trade. I had been saying I think the EU deal that we heard about a couple of weeks ago, with the US and the EU, was going to kind of pressure China to say, “Okay, other people are folding here. We’re going to have to do the same.” Keep in mind, China’s stock market is down over 22% since its peak in January, directly related to tariff talk. Meanwhile ours is just a few percent off its high. There is some pressure mounting against China.

Then of course we got Apple’s earnings that night, and Apple of course ended up jumping the next day and Wednesday of course US didn’t raise interest rates, but now it looks like they’re probably going to do it in September and December. They did change the language in some of their commentary. They said that the economic activity was, quote, “rising at a strong rate,” end quote. Of course later that day, we saw President Trump come out and say, “We may increase the China tariffs from instead of 10%, we’re going to raise it to 25%,” and so again markets move on that.

Thursday, as I mentioned, we had Apple becoming the first trillion-dollar company. What does it really mean to you? Not much. The fact that if you own and it’s going up, it’s a good thing. My point is is that whether it’s worth 999 billion or one trillion, it doesn’t change things. It is an interesting topic and it’s a huge accomplishment for a company that has been deemed as a failure early on back in the ’80s and times in the ’90s and here they are the first trillion-dollar company, so it is a big deal. What does it mean for the market? Does it mean something that we’re going higher or it’s going to signal the top? I don’t believe any of that, but it is a very great accomplishment.

Then of course, yesterday Nonfarm Payrolls Day, we had the report come out. All the experts were on CBC. 200,000; 225,000; 195, all these numbers of what the job creation was going to be for the month of July and of course it came in at 157,000, way off the radar from where all the expert economists were saying. Remember the estimate was for 193,000. So when you put all those economic analysts together it was supposed to be 193,000, it came in at 157,000. Now last month, June’s was revised up by 35,000. In fact, the last five months in a row had been revised up. So take some of this with a grain of salt because they’re always revised either up or down and we have a trend where they’re coming in lower and then they’re getting revised up.

In addition to that, we saw that there was a big chunk. I think it was 31 or 32,000 of the job lost. It was attributable to Toys R Us bankruptcy. So when Toys R Us went bankrupt, 31,000 jobs went away overnight and that was in July. So some people are saying, “Look, if weren’t for that, we would have seen a little different … Some of the numbers would have been a little different,” which is probably so. Again, some of that may or may not be accurate as far as how it’s massaged in the data. We know that unemployment rate is 3.9%, pretty much full employment. Things are still good, but is it weaker than expected? Yes.

So again, what we do on this show is not say, “Well, it should have been, could have been, would have been.” What we need to do is look at the facts. That’s important because what we’re seeing is some weakness in housing numbers. The last few reports we’re seeing a little bit of slow down. Some of these nonfarm payrolls we’re seeing an ISM services report that came out yesterday morning and was also weaker than expected. So we’re seeing a little bit of softness as far as expectations are concern. So the question remains, “Is the economy starting to peak out and slow down?” Now why that’s important is because it’s not necessarily about the economy growing. It’s about how fast it’s growing.

The GDP report that we got a few days ago showed that we have had eight quarters of GDP growth accelerating. So remember when it says 3% and then the next quarter says 3.1%, not only did we grow 3% but it grew even faster 3.1. So it’s as if the car is not just moving forward at 50 miles an hour. It’s going 55 and then the next time you check it it’s going 60, it’s accelerating. Oftentimes, markets move on the acceleration or deceleration of that number. So we’ve had eight quarters in a row of acceleration, which is huge.

So can we continue to get that? So are the expectations built in already to where if it starts to slow down the stock markets start to struggle? Perhaps 2018 has been somewhat pricing in that end that maybe it does start to slow down and that’s why it’s always about these numbers looking forward not backward. So if you’re wondering how can the market be struggling when we’re sitting here at eight quarters in a row, it’s because it was somewhat baked in and now it’s about what happens next quarter. We’re already looking at next quarter’s numbers. So that’s something interesting to watch.

Also on Friday, we saw that, again, later in the day we saw that it came out that Trump was willing to talk to China. Now remember early on Friday, China said, “We’re going to do some more tariffs,” and the market just kind of, huh, whatever. Larry Kudlow came on TV on Bloomberg and said, “Don’t underestimate Trump,” this, that and the other. When it came out that Trump said he’s willing to talk to China again, the markets kind of took another little leg up. Nothing huge but definitely had a little up bias to them to end the day on Friday. So we’re still getting this negotiating. You still see what’s going on here, which is I’ll up your tariff, I’ll do this. It’s all rhetoric so far, but it is starting to affect the way people behave a little bit.

Now we are just about getting through earning season. About 80% of the companies I believe have reported so far. Of those companies reporting, 80% of them have come in above their estimates. So four to five companies have reported better than expected. Remember there are some high expectations. These companies are coming even better than that. If that number sticks and that’s the final number just according to FactSet, it will mark the highest percentage of S&P 500 companies reporting a positive earnings per share surprise for a quarter since FactSet began even tracking this metric. You guessed it in the third quarter of 2008.

So this is good news but as I said just a few minutes ago, that’s great but what about going forward. The Bears would argue a lot of the reason these companies are beating earnings, companies like Apple. It’s not because business is so good, it’s because they are buying back their shares. When a company buys back their shares, there’s less shares outstanding which makes the profit easier to beat because the earnings per share are going up simply by the fact that they’re buying back so much stock and that is a real stat. Now we know Apple’s business is good, but it does beg the question of some of these companies, are they just manufacturing some of the bookkeeping, manufacturing these earnings growth? That’s why people watch buybacks and so forth.

As we’ve said, it is what it is. The fact that they are buying back stock and their earnings per share are growing up is one metric to look at. So you do have to look at cashflow. You have to look at earnings. It can’t just be about earnings. You have to look at all types of things, their assets. You have to really dig in to these companies before you buy them because these companies are smart and know that people do screens on software and just find earnings growth. It doesn’t really tell the full story. So there’s a lot of work that has to be done before you buy an individual company. These companies are very smart when it comes to let’s just call it tricking delay person who is not going to do the work. That’s why Facebook fell so hard because their expenses are going up. Cashflow is going down because they’re spending a lot of money to clean up their app, which we talked about last week.

So that was a quick rundown with some side notes but a quick rundown on what’s going on in the markets this week. I did want to point something out that I am seeing something that was really interesting that happened this week. It may have happened late last week, but this past week I think it was. The Vanguard, big mutual fund company, the largest mutual fund company put out a press release. Basically, the fund which has 2.3 billion dollars of Van … 2.3 billion-dollar Vanguard precious metals and mining fund will be renamed to Vanguard Global Capital Cycles Fund. Not only that they changed the name, they’re changing the strategy of the fund. So they have given up on precious metals and mining.

Now you can take this one of two As. You can say, “These guys are smart and they think that precious metals will never make any money.” I don’t take it that way. That’s what they’re thinking. I take it as a great potentially awesome buy signal. This is no different, no different than if you take a look at the companies that have been tossed out of the Dow Jones over the past few years or included into the S&P 500. They tend to move the opposite of what happens once people capitulate. Remember the people creating these indexes, the Dow Jones, the S&P 500 are people and they have emotions. When they’re company is not looking good, they want to get it out of there.

Vanguard is jumping the gun here and saying, “You know what? We don’t think precious metals make sense.” Precious metals commodities are an asset class and they’re giving up on them. It looks to me that this could be a really interesting buy sign, contrarian buy sign. I actually think also looking at gold itself is interesting right now. Now we own gold not a huge portion but depending on which strategy. We own our aggressive strategy has some gold miners. We own gold, the commodity and some or other strategies but small portion. I do like the technical setup in gold and gold had been hit pretty hard. Why? Because of the dollar going up. I think it’s interesting that, remember, bitcoin and the cryptocurrencies were seen as maybe the new gold substitute. Maybe that’s partially true, but they’ve really had a tough time the cryptocurrencies as of late. Here we are now with gold and silver and the mining companies really beaten up.

I mean if you look at the GLD, which is the ETF that tacks gold or the movement of gold, the thing just in the last I would say probably just two, three months down about 12, 13, 14%. But I think gold looks interesting here. I see people hating it, and there’s been a big move into financial assets in the last few years, right? Namely, stocks. It’s getting more narrow in terms of some of these fang stocks, and those types of large cap companies that dominate the indices. But what about real assets? They’ve been left for dead, and there’s a huge divergence between them, so there’s still a great opportunity in this market for rotation, and the rotation would be out of some of the financial assets that are looking more and more expensive and into some of these companies or areas like foreign stocks, which we’ve talked about; commodities, which we’ve talked about.

Now, are you going to own a portfolio full of all-commodities and all emerging market stocks? No, you would not. But, would you underweight the American stocks to overweight in other areas, or would you put new money to work in these beaten down areas? Our answer is: Yes, you should do that. Now, I say “should”, meaning that’s what we think … We’re doing, but I’m not saying you specifically should do this, because I don’t know your situation. I’m not giving you advice, but standing back, looking at the markets, where do I see opportunities? I don’t see them in some of the American technology stocks, let’s put it that way.

Stock Market CrashI just thought that was a really interesting, classic thing that we see. The world’s largest fund company is pretty much giving up on precious metals and gold and so forth. So, watch that. Now, one other thing I wanted to talk about today is: We’re seeing more and more articles talking about how the stock market could drop 50%. Why did they pick 50%? Are they doing any fundamental work? No, they’re not doing that. What they’re doing is they’re having recency bias. They’re looking back at the .com bubble. How far did the market fall? About 50%. How about 2008? How far did the market fall? About 50%. So our mind wants to extrapolate and say, “Well, what could the stock market fall this time? About 50%.”

It’s a big headline, right? And there’re articles all over the place about: “It’s going to crash! Market could drop 50%!” Here’s what I would say. Just a couple of things; I think, as I mentioned, recency bias is causing people to think there’s another 50% drop in the cards, because we’ve had two like that since Y2K. That’s recency bias. Whatever’s happened recently to us, we think it’s going to continue forever. If you go back and study history, 50% drops are pretty rare, two within an eight year period are really rare, and three within 18 years would be unprecedented. Could it happen? Sure, it could happen, but I’m not going to write articles saying, “It’s going to happen,” but fear mongering gets you on TV, gets you on the radio, sells newsletters, which most of these folks do. Most of these folks don’t manage assets. They strictly run around selling newsletters and scare tactics and conspiracy theories.

Could the stock market fall? Yes. Are there things we should be worried about in the market? Sure. Are there great things happening? Yes. Will they tell you those great things? No, because they’re one-dimensional. And look, we’ve been saying in writing for a long time that we think there are pockets of stocks in pockets of areas that could fall maybe 50%, because they’re over-valued. But rolling bare markets are more likely. As we’ve mentioned, energy already fell 50%. Retail stocks already had a crash, right? We’ve already seen things like that. Commodities have already crashed. So as the stock market matures, it’s extremely important to continue to own areas of the market that are cheap or haven’t participated, or already sold off.

You know, we have a dividend plus portfolio that we manage for some clients, and it decimally is taking on a more value tilt as we move along, and we’re happy to do so, because again, these cap weighted indices are becoming a popularity contest of expensive stocks, primarily in the growth area. Now, the other thing about this is; when you see articles saying, “Could the stock market crash and fall 50%?” Look, let’s just say it did. Should you have all your money in the stock market to begin with? Well, if you have time on your side, you’re probably going to make more money than anybody else over the long term, but for most people, they don’t have all their money in the stock market.

They have real estate, they have income producing securities. They are lending some of their money, right? This is where diversification comes into play, and it does work. You have to have income producing securities so that you can take advantage of drops. And now what I’ll say, lastly, we’re not glib to the fact or ignorant to the fact that stock market could go down. But we have ton of indicators. We watch minute by minute to give us signals of weakness, and we don’t know when we’re going to wake up and see the DOW down 300 points. We don’t know that. Nobody else does.

What we think we’re pretty good at is identifying bare markets versus bull markets, and we don’t see evidence of a bare market starting any time soon. So if and when we do see our long term indicators start to turn negative, we will adjust accordingly. But right now, they’re still bullish. As always, a 10% correction, as I said, can happen. A 20% drop can happen too, but be careful about what you read. I would also say, “Don’t fill your inbox or your television screen or your Twitter stream or whatever, with too many people that agree with each other.” Right? It’s really easy to have negative things coming in, and all of a sudden, you start hunkering down and you’re sitting in cash the last three or four years, not making any money.

Right? Or the opposite, where you’re completely ignoring when things are starting to slow down, and are starting to get risky. So how about a more balanced agnostic approach; is what I would say. Now, the last thing I want to talk about today is basically the fact that interest rates are rising, as we’ve said, and it’s now … The two year rates are now higher than the dividend yield. So, what we’re seeing is, potentially … And you’ve seen … They’ve held up okay, but if you look at things like some of the utility stocks or things like that, are the marginal buyers that are buying some stocks strictly for the dividend now abandoning that, because they can now earn some yield and see these in money markets.

I think on the margin, that’s happening. We’re also seeing short-term rates go up, that’s affecting borrowing, right? In other words, just credit lines that maybe were 4% before are now 6%, and it’s causing people to rethink how they use credit. We know credit is an issue in this environment. A lot of people have way too much money borrowed, and that could be something that we need to continue to watch as things go on here and mature. But we haven’t seen defaults rise yet, or things like that. Those are the types of things we need to be watching as we move along. It’s interesting though, that that’s now becoming something competitive. We’re starting to see some yield come back into the market, and that can compete with stocks or bonds or whatever else there may be.

All right. I know that was a lot of information. Hey, don’t forget. eggersscapital.com, and don’t forget to share this. We are on iTunes if you want to listen to the podcast. Stitcher Radio, iHeartRadio as well. We’re on Spotify as well. We have an Instagram page, Eggerss Capital Management. You can see some charts that we’re watching throughout the day and things like that. The Twitter stream @KarlEggerss, so that you can see developing things, maybe some sarcastic comments thrown in here or there. Maybe a lot of them, for all intents and purposes, but we use lots of ways to communicate with you.

The best way, eggersscapital.com. Of course, if you need anything from us, our website is Eggersscapital.com, and our telephone number is 210-526-0057. Hey guys, have a wonderful weekend, and we’ll see you or listen to you, or talk to you right here next week on the Eggerss Report. It’s your investing playbook.

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This show is for entertainment only, and information provided by the hosts, guests, and this station should not be deemed as advice. Your investment decisions should be based on your own specific needs. You should do your own research before you make those decisions. As President and CEO of Eggerss Capital Management, Karl Eggerss may hold securities mentioned in the show for himself and his clients. Just don’t buy or sell anything based on what you get from radio or TV. Use your own judgment or get yourself a trusted advisor.

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