The Most Dangerous Stock Market Ever? Either Way, Have A Plan

Today’s stock market may not be as dangerous as 2000’s dot-com euphoria or 2008’s asset balloon. Why not? Global central banks are likely to act quicker and with far more “shock-n-awe” to minimize bearish price depreciation than they did in the previous sell-offs.

Some argue that policy efforts would fail to reinvigorate yet another wealth effect because central banks are out of ammunition. I disagree. Indeed, I expect that monetary gamesmanship in the near future will result in an average 30-year fixed rate mortgage of 2% for the 2020s. Similarly, stocks will benefit immensely from borrowing cost manipulation.

Of course, nobody knows how the current bull-bear cycle will play itself out. Might the next stock bear destroy more portfolio wealth than the previous two did? If so, commentators will likely point a collective finger at extreme leverage, colossal overvaluation and multilayered computerization.

Consider the excessive leverage being employed to own equities in 2018. For one thing, margin debt is greater than at any previous moment in history. More importantly, even when accounting for inflation and subsequently comparing margin debt to the economy itself, leveraged speculation has surged to never-before-seen heights.

According to Jesse Felder of the Felder Report, a significant negative correlation has existed between margin debt-to-GDP and 3-year forward returns since the mid-1990s. In particular, the last two times that the ratio reached 3%, 50% stock market declines were not far behind.

On Monday, Warren Buffett chimed in on the issue. He told CNBC, “It is crazy in my view to borrow money on securities… My partner Charlie says there is only three ways a smart person can go broke: liquor, ladies and leverage. Now the truth is — the first two he just added because they started with L — it’s leverage.”

Is it possible that the world’s most admired investor is fearful of what a titanic deleveraging would do to stock prices? More likely, he is worried about leverage as well as overvaluation.