ISSUE 03 VOLUME 01 SEPTEMBER 2018

Stocks Surpassing January

Highs: Are We Peaking, or
Will That Come in Late 2019?
By Harry Dent, Editor

The Trump rally into January 2018 looked like the classic final blow-off top.

It had been advancing in a clear channel, then it broke above that in a classic ‘overthrow’ pattern, followed by a
sharp correction.

Was this the beginning of the final and greatest crash?

My first problem with that scenario early on was that the major bubble peaks in stocks have averaged a 42%
crash in the first 2.6 months. That comes from seven global stock bubbles since 1929. The range is 30–50%.

Instead, the S&P 500 only crashed 12%, and has moved mostly sideways this year with an upward bias.

My second problem was that such extended sideways patterns, following a strong advance, tend to break up in
the same direction to new highs — not down.

And now, in late August, the S&P 500 has followed the NASDAQ’s break to new highs months ago.

The Dow is just 3% behind the S&P in doing that.

Only the broader NYSE is lagging further than that.

In This Issue
Is this a slight new high — to be followed by that
sharp 40% or so crash in the coming months that The Unexpected Second Scenario:
forebears the next great bubble crash? Or will How to Spot a Recession When
stocks pull back more modestly after this break
No One Sees It! ......................................2
up while the Trump rally continues well into 2019
before we see an even bigger blow-off top — like https://www.portphillippublishing.com.au/
Dow 30,000? publications/bmb/
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Those are the two most likely scenarios as we approach cs@portphillippublishing.com.au
the late stage of the longest bull market rally without a with your feedback.

1
20% correction.
As at 21 August, this rally from early November
2009 has lasted the same 3,453 days that the
longest one from late October 1990 into early March
2000. So, we’re now in new territory for bull markets
on that measure.
Many classic indicators are not pointing to a major
high and crash ahead.
The advance/decline line measures how broad the
rally is and that tends to narrow in the late stages of
a major bull market. That line has continued to make
new highs with this rally and is saying it’s still healthy.
However, the FAANG stocks (high-tech large-cap
leaders) are showing such narrow buying, while the
tariff and trade war threats favour small-caps over
large, as they are less exposed. That could throw this
indicator off.
The yield curve — 10-year Treasury yields minus six
months — tends to invert before a major top and
recession. This appears to be approaching, but has
not occurred yet.
And even if it does, it can be many months before the
downturn starts.
Gross domestic product growth is accelerating out of
the 2% doldrums of past years.
Normally it would decelerate a bit before a major top.
The Fed is raising rates which will eventually trigger a
top. So far inflation and long bond rates haven’t risen
enough to signal danger, as investors expect rates to
rise when economic growth accelerates.
Household net worth just passed $100 trillion after
peaking at $69 trillion in late 2007 and $45 trillion at
the 2000 top. Compared to GDP it has risen from just
over 4.4-times in 2000 to 4.8 in 2007. Now it’s just
over five times that amount.
This is another good sign touted by the bulls, but
I think this is one of the biggest reasons that the
economy has been holding up amidst declining
demographic trends and record levels of debt.
Central banks — and now Trump through tax cuts —
have been able to dramatically goose financial assets
and net worth while real wages continue to stagnate
or fall, all the while economic growth has been subpar.
But as we’ve seen thus far and throughout history,
such bubbles are fleeting and always burst.
Trump has been proposing a second tax cut through
adjusting capital gains for inflation that he may
be able to force through without going through
Congress. That will again favour the top 1–10%, but
not the broader economy or his supporters.
Suffice it to say, the broader consensus is that this
market is not ready to top yet. But I’ve a sneaking
suspicion that we may see a surprise crash just
ahead; one that almost no one expects.
The actions of stocks and some key indicators over
the next few months should tell us which scenario is
more likely to come…
The danger is that if the near-term top (the
second scenario) is unfolding, the market could
get hit quick and hard by that likely first 40%
or so crash in the first two to three months.
We’ll have to watch carefully for signs of that —
like significant new lows from 2018. And even
if some investors get caught in it, the time to
sell is in the likely strong bounce that typically
follows such a crash.
Since the first scenario is the most favoured — a top
by late 2019 rather than anytime soon — I’ll cover the
second scenario here in case it sneaks in.
The Unexpected Second Scenario: How to
Spot a Recession When No One Sees It!
How many experts saw the 2008 crash and
financial crisis — the largest since the Great
Depression — coming?
We noticed the slowing of Baby Boomer spending,
not just years or months, but decades in advance.
The key trigger was the subprime crisis. Even Ben
Bernanke didn’t see that as a problem — and
commented publicly that it was easily containable.
Housing prices actually peaked in early 2006, and we
called that one in late 2005. It wasn’t because of a
slowing economy at that point. It was high prices and
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bad loans due to the ‘good times’.

The leading experts didn’t see that crisis and

crash coming.

Only contrarians like us were warning.

Even the smart money index below didn’t see that one
coming as the overvaluation factors were not there.

This time is similar. Contrarians are warning again, but

Mainstream Media is even less worried about a crash
with the impacts of free money, tax cuts, and a short-
term pickup in economic activity.

I listen less to the classic gold bugs. They’re warning

about inflationary versus deflationary. I disagree with Source: Bloomberg
them radically on how this is to play out.
This index doesn’t watch anything like the advance/
The dollar is strong, and far from crashing. decline line or the yield curve, which is something I
like about it.
Meanwhile, gold’s weak. Ditto for cryptos.
Stock prices are initially weighed at 10:00am, then
The gold bugs just let their sentiments get the best
subtracts prices at the close. The logic is that the
of them hence why I don’t often listen to them, even
dumb money reacts to the news and market openings
though they are right about a financial crisis coming.
every day. That’s when it trades the most.
I look more at the growing number of smart money
Smart money watches throughout the day, even
billionaires that’ve been issuing warnings in the last
testing the markets, and makes its bets more into
year or two. People like Ray Dalio, George Soros,
the close.
Paul Tudor Jones, and Mark Cuban. These guys have
enough money and guts to do what Baron Rothschild This chart shows that the smart money did not get
claimed was his key to success in the 1800s: ‘I out ahead of the rally into late January 2018.
always got out a bit early.’
They didn’t see that as a major top, and it just now
Why? has proven not to have been. Instead, they haven’t
been buying into the rally since the bottom in late
That first rapid and nasty crash. The smart money
March, nor into the new highs being made in one
exits at the speed of light while the dumb money is
index after the next.
left behind.
They are selling way more than they are buying,
So here’s the first indicator I present for the lesser
and consistently so since the top — seven months
expected, but potentially surprising second scenario:
ahead of the new August retest of the highs. And it’s
A top in the latter part of 2018. The Smart Money
a similar warning to the flagged raised seven months
Flow Index, which is far more bearish than coming
before the dramatic 2000 bubble and top.
into the 2000 or 2007 tops.
Most importantly, the sharpness of the selling
suggests that this next crash could be greater
than the last two…

We’ve been saying that for a long time.

This chart — and the growing number of cautious

billionaires — is the strongest evidence for the
second scenario.

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Our investment services continue to play the uptrend, towards $1,375-plus back in July of this year.
and will be quicker than most to change gears.
The other exception goes back to the aftershock
But keep in mind that in the first scenario with a bubble into early 1937 that saw a peak (from a
continued bull market into 2019 that this indicator second demographic wave of immigrants) and then
could just continue to crash. That would simply an attempt at a new high that failed — and then the
suggest an even bigger crash in late 2019. sharp crash you would normally expect, just a little
later than normal.
So this indicator, even if it turns out to be accurate,
doesn’t have to signal a top just around the corner.
It is, however, signaling a major crash in the coming
future, and that could very well be just around the
corner. That’s the risk here…

There are two prominent bubble tops and crashes that

didn’t see sudden 40%-plus crashes right off the bat.

The most recent was gold.

It peaked in late 2011 after bubbling much more than

stocks in the 2009–2018 bubble — 7.7-times over
10 years versus 4.3-times over 9.4 years so far for
the S&P 500. I always have to remind the gold bugs
that it was a bigger bubble than stocks! Gold crashed
21% and went sideways for just over a year in a Source: Yahoo! Finance
channel before breaking down, sharply.
There was a third (and final) aftershock bubble
following the big crash of 1929–32.

The markets went up sharply into early 1937, then

crashed 40% in a matter of months. After the top, it
went sideways for five months before crashing.

If this scenario follows as the above chart would

suggest, then it should be crashing soon.

But, again, this is not the ideal scenario for such a

major top. The second scenario of major new highs,
then a sharp 40% crash into early 2020 is a better fit.

When it comes to stock valuations, the Cyclically

Adjusted PE Ratio (or CAPE Ratio) is the most
respected and trusted.
Source: Yahoo! Finance
Those valuations are higher than any of the seven
I believe gold is likely to bottom somewhere between
major tops in the last 100 years, except for the
its 2008 crash low of around $700, and its bubble
2000 tech bubble. And we’re now at just over 33.3
origin in mid-2005 of around $400–450.
compared to 32.6 in 1929, and an off-the-charts
Currently, I favour the higher target area. Gold has 44.2-times earnings at the 2000 top.
been one of the few bubbles to hold up better than
I’ve been warning for years now that it’s unreasonable
our bubble model would suggest, but it has still
to compare now to the 1995–2000 bubble given GDP
crashed, and I feel is likely to again further ahead. I’ve
growth was about double this bubble and productivity
been warning about this following the overdue rally

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was way higher.
The 1990s were simply the best decade in US history
for stocks and the economy.
What we’re in now is the weakest boom and
recovery yet.
And totally artificial on top of all that!
There are two other indicators I’m tracking. They’re
the most overvalued ever, and suggest we are very
close to a top either now or by late 2019 at the latest.
The first is the price-to-sales index for the S&P 500.
Source: Yahoo! Finance
This index gets around the artificial impact of low
interest rates on earnings, along with all types of
accounting tricks that seem to most come out of the
closet in bubbles such as the one we’re currently in.
It measures if the stock price is growing in line with
business growth. And at 2.4, it’s a record high saying
that prices are way overvalued.
Sales at the January top (2.4) were even a bit higher
than the 2000 top (2.3).
The second indicator is the total market capitalization-
to-GDP index.
Source: St Louis Federal Reserve; Wilshire.com
It takes the total market value of the broadest Wilshire
5000 index of stocks and compares it to GDP.
This great indicator is now as high as the 2000 top,
and much higher than the 2007 top, or the 1972 top
of the last generational boom.
Any further advances would only make this a clear
new record high.
This is clearly another reason for caution in the market.
John Hussman has another great indicator that
measures stock valuations against 10-year average
annual gains to follow. That model says you would
lose 2% a year for the next decade, and has nothing
to do with the strong fundamental downward
demographic trends or excessive debt that we also
measure, which just adds to the downside.
Even though there are not meaningful divergences
in the US major stock indices, there’s a gaping
divergence between the US and developed countries,
and the emerging countries.
The EEM ETF for emerging countries has recently
been down just over 20% from its January high, and
is currently down 19%. It’s possible it could make
a new high if the Dow runs up to 30,000 in 2019
before peaking.
But that wouldn’t be the most likely scenario.
Especially with the US dollar potentially on another
major rise since its low around 88 in March.
I predicted recently that the dollar looked like it
was about to break up out of a reverse head-and-
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shoulders pattern, and it has.
It’s projected to rise to around 102–104 in the
months ahead.
Between that, and more Fed rate hikes, these
countries will be hurting, as they tend to borrow at US
rates and pay back in US dollars.
Source: Yahoo! Finance
Turkey has been the poster child for bad debt and a
crashing currency after Trump slapped tariffs on Erdogan.
But the elephant in the room is, of course, China. Its
second bubble burst 49% from its 5,200 high in late
2015/early 2016.
There was a dead cat bounce following that crash for
years afterwards.
Since March the Shanghai Composite has fallen
26%, and is facing major support at 2,638. A break
much below there could start another sell-off in China
that would rock the emerging markets realm and the
global economy.
This would only occur near-term if the Chinese stay
defiant on tariffs and don’t negotiate in earnest. But at
least this represents a clear warning sign if it breaks
below 2,600.
The next target would be 2,000, and the ultimate target
would be its pre-bubble low of 1,000 in late 2005 — an
84% crash from the all-time high of late 2007.
Source: Yahoo! Finance
A more general view of the scenario comes from
looking at the last time we had a series of three
bubbles and crashes.
This occurred 90 years ago, and was two-times the
magnitude of our fundamental 45-year Innovation Cycle.
Our 30-year Commodity and Inflation Cycle becomes
more exaggerated every 60 years, and it seems to be
the same for the Innovation Cycle.
There were three bubble crashes between 1914 and
1942: 1920–21, 1929–32, and 1937–42.
The second bubble and crash was the most extreme
in that series and that is the more natural sequence.
This time it is the final and third bubble that should be
the worst.
Central banks didn’t let the second bubble burst fully,
didn’t allow debt to deleverage, and didn’t allow for
bad banks and businesses to fail.
Now this one is pumped up with $16 trillion in global
QE. The major tax cuts in the US aren’t doing Main
Street any favours either.
I believe we’re due for the worst of that cycle between
now and 2022 for stocks, and into 2023 or so for real
estate and the rest of the economy.
But we could see Dow 30,000 first…
6

Source: Bloomberg
Yes, the worst may be yet to come. It would appear
that we merely deferred the real crisis in 2008 that
looked just like 1930 until massive QE reversed the
trend artificially.
It’s just a question now of whether the potential
surprise stock crash starts in late 2018 and the
recession/depression by early 2019, or one year later
in late 2019.
We don’t get over this Winter Season until 2023 or
so. That’s still five years from now, leaving plenty
of time for a scenario similar to what happened in
1929–33 to play out.
This over-amped economy is running out of tricks.
And Donald Trump is running out of time. Nixon was
on this very same 45-year cycle back in 1973–74 —
as Andy Pancholi has been reminding me in the past
several months.
On that Watergate cycle, Trump could be forced to
leave office by late 2019…and it was he who just
said, ‘If I’m impeached the stock market will crash.’
That wouldn’t be the biggest reason.
The worst part of the 1973–74 crash happened after
Nixon fired the special prosecutor. The Saturday Night
Massacre was a pivotal point…
The underlying cycles keep closing in, and the last
trick appears to be an executive order. The order to
adjust capital gains for inflation to lower those already
low taxes for the rich even more. That could be the
last trick.
My forecast is that this blow-off rally doesn’t last past
late 2019. This 45- and 90-year cycle favours the
peak in late 2019 if the S&P 500 hits 3,300, or the
Dow nears 30,000. Though it could fail earlier due to
the extremely volatile political environment.
Regards,
Harry Dent,
Editor, Boom & Bust Letter
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