Prepare for the biggest stock-market selloff in months, Morgan Stanley warns

By Ryan Vlastelica, MarketWatch

The U.S. stock market has been partying all throughout July, and a hangover is coming.

That is according to analysts at Morgan Stanley, who said that Wall Street’s rally is showing signs of “exhaustion,” and that with major positive catalysts for trading now in the rearview mirror, there’s little that could continue to propel equities higher.

“With Amazon’s strong quarter out of the way, and a very strong 2Q GDP number on the tape, investors were finally faced with the proverbial question of ’what do I have to look forward to now?’ The selling started slowly, built steadily, and left the biggest winners of the year down the most. The bottom line for us is that we think the selling has just begun and this correction will be biggest since the one we experienced in February,” the investment bank wrote to clients.

The decline “could very well have a greater negative impact on the average portfolio if it’s centered on tech, consumer discretionary and small-caps, as we expect.”

A correction is technically defined as a decline of at least 10% from a recent peak. Both the Dow Jones Industrial Average DJIA, -0.57%  and the S&P 500 SPX, -0.58%  corrected in early February, on concerns that inflation was returning to markets. While the Dow remains in correction territory—meaning it hasn’t yet risen 10% from its low of the pullback—the S&P exited just last week, following its longest stint in correction territory since 1984. The Nasdaq Composite Index COMP, -1.39%  never fell into correction.

Equities have done well of late, with the Dow up 4.3% in July. The S&P 500 has gained 3.1% in the month while the Nasdaq has advanced 1.6%, hitting multiple records along the way, though it has stumbled badly in the past three sessions.

Much of the rally has come on the second-quarter earnings season, which has both shown strong growth and featured a high number of companies topping analyst expectations. While there were some high-profile disappointments, including from Netflix Inc. NFLX, -5.70%  and Facebook Inc. FB, -2.19% —which suffered its biggest one-day drop ever after its results—market participants have generally looked past them.

“We must admit, the market sent some misleading signals over the last few weeks by limiting the damage to the broad indices when Netflix and Facebook missed. We believe this simply led to an even greater false sense of security in the market,” wrote the team of Morgan Stanley analysts, led by Michael Wilson, the firm’s chief U.S. equity strategist. Both Facebook and Netflix’s shares fell into bear-market territory on Monday, defined as a drop of at least 20% from a recent peak.

The firm forecast “a rolling bear market,” during which “every sector in the S&P 500 has gone through a significant derating” with the exception of tech and consumer discretionary. Those two sectors have contributed the bulk of the market’s advance in 2018; tech has risen 12.5% while the discretionary sector—boosted by Amazon and Netflix, both of which are up more than 50% year-to-date—is up 12.8%.

That these two industry groups haven’t fallen much doesn’t mean they won’t, Morgan Stanley warned.

“While it is possible tech and consumer discretionary stocks won’t experience the derating witnessed in other cyclical sectors, we think it is unlikely and are only emboldened by the misses from Facebook and Netflix and the price action last week,” they said.

“We recognize that money can also move from these sectors to others thereby leaving the S&P 500

around current levels rather than falling 10% as we expect,” they said.

Wall Street is sending huge warning signs for stocks

Count Marko Kolanovic, JPMorgan’s global head of quantitative and derivatives strategy, as one of those stressing caution. In a client note, he said that record-low volatility should “give pause to equity managers.” Kolanovic even went as far as to compare the strategies that are suppressing price swings to the conditions leading up to the 1987 stock market crash.

“The fact that we had many volatility cycles since 1983, and are now at all-time lows in volatility, indicates that we may be very close to the turning point,” he said.

Baupost Group, a $30 billion fund, recently highlighted the lack of price swings as a harbinger of pain to come, calling it a possible “accelerant for the next financial crisis.” Meanwhile, Highfields Capital Management, which oversees $13 billion, said that low volatility is giving people the false impression that the market is risk-free

Going beyond the much-maligned low-volatility environment, Bank of America Merrill Lynch has its own reasons for expecting an upcoming rough patch in stocks — one it sees coming sometime soon.

Michael Hartnett, the chief investment strategist of BAML Global Research, points to how the S&P 500 has continued climbing to new highs, even as the size of the Federal Reserve’s balance sheet has stayed relatively unchanged. He says this divergence is a “classic euphoria signal.” Such overexuberance has historically been a sign that investment sentiment is overextended.

Crash that may send Dow down…17,000 points
By Stephanie Landsman

Harry Dent is arguing that the Trump rally is setting investors up for an inevitable stock market crash.

Investors have embraced Donald Trump’s victory by sending stocks on a tear to new record highs. Dent, however, thinks there’s trouble brewing.

“I think this is going to be a stock market peak of a lifetime followed by a crash very similar to the early 1930s. This happens once in a lifetime,” Dent Research Founder Harry Dent recently told CNBC’s “ Futures Now .”

He added: “I think this is the last rally in this bull market.”

Dent may be calling for the rally’s last hurrah, but he’s also forecasting another ten to 20-percent jump for the Dow over the next few months.

“The markets are assuming that he is going to create three to four percent growth on a sustainable basis,” said Dent. “It is demographically impossible…. When the markets figure this out, they are going to crash.”

Dent makes the case that the U.S. workforce will see negative growth, estimating that the population will grow just over a quarter percent over the next 50 years. He also points to rock bottom productivity that not even tax cuts can solve in the immediate term.

“You can’t have stocks keep going up at this rate when earnings are going nowhere,” said Dent. “”I think it [Dow] is going to end up between 3000 and 5000 a couple years from now.”

Debt Bubble

What we have is a debt bubble. The rising debt is the stimulus funding the rally on Wall Street. QE1, QE2, QE3, Operation Twist, bailouts, handouts, and now $85 billion injected into the system every month. Hmm, I wonder if there is a coincidence between enormous debt creation and 43 new highs in the Dow this year?

No, the stock market is not in a bubble. It is reacting normally to new injections of cash and buyers. The debt bubble, however, is a different matter. These things end badly, historically. Eventually, somebody has to pay the Piper.

The stock market is up, while the economy isn’t. Since the stock market is supposed to reflect the economy, it looks a bit overvalued.

There is also a good reason for over-valuation: the cheap money policy by the Fed means that there is no money in bonds, so many investors have loaded up on stocks, which drives their price up.

The NASDAQ and Russell 2000 are in bubbles right now. Once the fed starts increasing its interest rate, the stock market will drop like a rock. Continue reading: Debt Bubble

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