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The market will crash this year — and there's a good reason why

FILE – In this Jan. 11, 2016, file photo, specialist Anthony Rinaldi is silhouetted on a screen at his post on the floor of the New York Stock Exchange. (AP Photo/Richard Drew, File)

Thomas H. Kee Jr. is president and CEO of Stock Traders Daily.

The market is going to crash this year, and there is a very good reason why. The amount of money chasing stocks is drying up considerably, natural conditions are prevailing, and it is happening on the heels of the most expensive bull market in history.

The stimulus efforts of global central banks created a fabricated demand for stocks, bonds, and real estate, ever since the credit crisis, but as of April 2018 those combined efforts are now a drain on liquidity. As recently as last September the combined effort of the ECB and the FOMC was infusing $60 billion per month into these asset classes, like they had almost every month since the credit crisis — but now they are effectively selling $30 billion of assets per month. That is a $90 billion decline in the monthly demand for assets in seven short months.

Central banks are now a drain on liquidity, and it is happening when natural demand levels are significantly lower than where current demand for stocks, bonds, and real estate appears to be.

According to The Investment Rate — an indicator that measures lifetime investment cycles based on ingrained societal norms to identify longer term stock market and economic cycles in advance — we are currently in the third major down period in US history. The rate of change in the amount of new money available to be invested into the U.S. economy declines every year throughout this down cycle, just like it did during the Great Depression and stagflation. This down cycle also started in December of 2007.

Although the market began to decline directly in line with The Investment Rate’s leading indicator, the declines did not last very long. The Investment Rate tells us that the down period lasts much longer than just the credit crisis, and the declines The Investment Rate suggests are rooted in material changes to natural demand levels based on how we as people invest our money, so it identifies natural demand. The natural demand levels identified by The Investment Rate are much lower, and they decline consistently from 2007.

As much as The Investment Rate serves to identify natural demand levels, when stimulus was introduced by Ben Bernanke a second source of new money was born.  The stimulus efforts by the FOMC and the ECB added new money to the demand side of stocks, bonds, and real estate, with the intention of spurring prices higher to induce the wealth affect. The policies were successful, asset prices have increased aggressively, but there are repercussions.

Asset prices increased so much that the valuation of the S&P 500, Dow Jones industrial average, Russell 2000, and NASDAQ 100 at the end of last year made them more expensive than in any other bull market in history. In other words, we just experienced the most expensive bull market in history, and the PE multiple of 25 times earnings on the S&P 500 was driven by the constant capital infusions coming from central bank stimulus programs.

Not only were these programs unprecedented given their size, but they also told us what they were going to buy, when they were going to buy it, and how much they were going to buy, every month, in advance, every year since the credit crisis. At no time in history has Wall Street been able to identify when buyers were going to come in like they have during this stimulus phase.

However, now the stimulus phase is over and not only are these central banks no longer a positive influence on liquidity, but they are now removing liquidity from the financial system as well. 

This is happening at a time when natural demand levels as those are defined by The Investment Rate are also significantly lower than where demand currently seems to be, and that creates a double whammy on liquidity. The demand for equities this year is far less than it was last year as a result of these two demand side factors. Because price is based on supply and demand, and because demand is cratering, prices are likely to fall. This applies to stocks, bonds, and real estate.