U.S. Stock Market: Is Another Crash Like The One In 1987 Possible Here?

Of course, the answer is yes!

Certainly possible, but maybe not probable? Please note the question mark behind this last sentence.

In my view, the probability of a stock market crash like the one experienced in 1987 has risen dramatically in recent weeks. If there is a crash, here is the list of contributing factors that will be on the post-mortem:

1. Most investor groups are fully invested.

2. In fact, NYSE Margin Debt is now at a record high, which means that "fully invested" now translates into greater than 100% invested (with the leverage of margin debt).

3. Complacency among portfolio managers and individual investors is now at the highest levels since 1987 as measured by the latest Investors Intelligence sentiment survey.

4. Bullish investors are now "certain" that the so-called "Yellen Put" will protect them from any meaningful stock market decline. This reminds me of the so-called "portfolio insurance" madness in 1987, where many fully invested portfolio managers thought they could increase their normal allocation to stocks to dangerous unprecedented levels with the idea that on any correction they could quickly sell stock index futures to hedge and protect themselves. Of course, they never realized that the market would decline 36% over 55 calendar days and 23% in a SINGLE trading day. As was the case then in 1987, and is still the case now, when the proverbial "shit hits the fan", who will step in to catch the falling knives?

5. It doesn't matter whether or not Scotland votes in favor of independence on Thursday, September 18th. The "horses have already left the barn, and the barn doors are shut". The whole idea of independence for Scotland and a long list of other regions (i.e. Catalonia in Spain) is now out there and will result in the formation of many new independent nations over the next several years. The EU as we know it today will NOT survive. The economic and political chaos from this inevitable outcome is now only beginning to be realized by investors.

6. Investors have completely underestimated the potential ramifications of the ongoing crisis in Ukraine. Sanctions against Russia are already being ratcheted up by uninformed leadership across the EU and in here in the United States. However, President Putin of Russia clearly holds all the cards in this "battle", and his longer term objective is a Russian-controlled Ukraine. Yes, Putin has already won the "war" in Eastern Ukraine, but he won't stop there. Kiev is his ultimate goal, and I for one don't want to bet against him. And on his way to Kiev, the potential dislocations in the financial markets can not be understated.

7. Corporate share buybacks, the lifeblood of the U.S. stock market over the last five years, are waning and will no longer provide the necessary support for higher stock prices.

8. Corporate profit margins, now near record levels, will soon deteriorate rapidly as the U.S. economy falters in response to significant mistakes in U.S. fiscal and monetary policy that are about to unfold.

9. The U.S. Federal Reserve is about to telegraph a path to higher short-term interest rates (away from its current ZIRP). While I think this is a significant mistake (rates should remain near zero to meet the challenges immediately ahead), it won't be the first time that the Federal Reserve (and the U.S. Treasury) has made a critical blunder at a key time in the economic business cycle.

10. Monthly-chart sell signals have been triggered by my computer trading system in most major indexes for the first time since July 2007.

Russell 2000 Monthly Chart with Computer-generated Buy & Sell Signals

NY Composite Index Monthly Chart with Computer-generated Buy & Sell Signals

REIT Index (IYR) Monthly Chart with Computer-generated Buy & Sell Signals

Google (GOOG) Weekly Chart with Computer-generated Buy & Sell Signals

Philadelphia Semiconductor Index (SOX) Weekly Chart with Computer-generated Buy & Sell Signals

Merck (MRK) Weekly Chart with Computer-generated Buy & Sell Signals

U.S. Stock Market: Good News Is Bullish, Bad News Is Bullish ??

For bearish traders and investors, Friday was a tough day. Early morning losses in most share prices proved short-lived and two major closely-watched indexes actually rebounded to post new all-time record highs (the Dow Jones Transportation Average and the S&P 500 Index).

While it has always been difficult (and sometimes impossible) to predict where stock prices are headed, now it's even a challenge to explain share price movements after the fact! Bad news (i.e. wars, famine, macro-economic melt-downs, debt crises, political scandals, droughts, polar vortexes, revolutions, negative corporate earnings, Fed tightening, record IPO's, overbought technicals, extreme sentiment readings, etc.), no problem, buy stocks! Good news (i..e. dovish Draghi, dovish Yellen, positive corporate earnings, ongoing share buybacks, cease fire I, cease fire II, cease fire III, cease fire IV, etc.), excellent, buy stocks!

Early weakness in U.S. stocks on Friday could have been related to the "less than positive" U.S. Employment Report, as released by the Labor Department at 8:30 AM Eastern Time Friday morning. Or maybe it was Thursday's unfriendly hawkish rhetoric on monetary policy from the new Cleveland Fed President Loretta Mester that weighed on stocks. Or maybe traders and investors sold stocks early Friday thinking that weekend news from the Mideast and the Ukraine might not be favorable. Whatever the reasons for the Friday morning swoon, the tone quickly changed as buyers stepped in and most major indices fought back into positive territory by mid-day. The rebound and subsequent rally picked up steam in afternoon dealings and most stock indexes ended Friday at their highest levels of the day.

I am not sure what time on Friday Goldman Sachs reversed its short-term view on stocks from bearish to bullish, but this may have also been a factor in Friday afternoon's rally. In July, Goldman Sachs (GS) issued a research report indicating that U.S. stocks were 30% to 45% overvalued, but now GS thinks that Q-4 2014 will be great for stocks (+3.3%) and the 12-month view looks even better (+12.0%). I wonder if the upcoming Alibaba IPO has anything to do with Goldman's change of heart toward U.S. equity prices. Goldman has been named the "Stabilization Agent" for Alibaba's historic Initial Public Offering (potentially the largest IPO ever at $20+ Billion).

Let's talk about Alibaba for a moment. The much-touted "road show" for this IPO begins this coming week and the IPO itself will probably be launched the following week (perhaps September 18th). Early reports indicate that $20 billion to $24 billion will be raised in this IPO and that Alibaba's market valuation will then be in the neighborhood of $150 Billion to $160 Billion. Of course, this IPO will almost certainly be oversubscribed and then quickly trade with a premium of at least 25%, which will take BABA's market valuation north of $200 Billion! If I had to guess, I don't think Goldman Sachs will be stressed as the "stabilization agent" for this particular IPO. Just a guess on my part!

So where does that leave the bearish camp in terms of the U.S. stock market?

Stressed, very stressed, to put it mildly !!

While I am sure there is a potential catalyst out there that will upset this bullish applecart, I just don't know what it is right now. In July 2014, my computer trading system triggered monthly chart sell signals in most major stock market indexes for the first time since July 2007. Among the 30 component stocks of the Dow Jones Industrial Average, monthly chart sell signals are now in force in 10 separate stocks, and weekly chart sell signals are now in force on an additional 7 stocks. The DJIA itself is also now on a monthly chart sell signal from July 2014.

While clearly among the "lost sheep" in this incredible bull market, I am not convinced that the right path is to now follow BABA and Goldman Sachs into the promised land. Instead, could Goldman Sachs actually be the proverbial "Pied Piper" for stock investors now? I think so!

Postscript (added Sunday, September 7th): Will Scottish voters choose independence on September 18th? Add this increasingly likely scenario to the list of potential Black Swans for the global financial markets. And just for fun, let's add the unlikely event that the Alibaba IPO will not be well received next week to the growing list of potential Black Swans. With a possible market valuation of $175 billion, BABA is a "must own", right? I guess we will soon see! And one last minor thought...if I may be so bold. It looks to me like Russian President Putin is 100% confident now that neither the U.S. nor NATO will take any substantial military action to stop him in Ukraine. So what's Putin's real and final objective there? Kiev is the answer, of course! Restore ousted President Viktor Yanukovych to power in Kiev, that's Putin's goal, and I for one don't want to bet against him! Yes, let's add this "speculative" scenario to the list of Black Swans!

What's it going to take to break this market? The answer may be as simple as a change in just two critical supply and demand factors. The supply side is relatively easy to measure. While secondary offerings are part of this picture, the main variable is Initial Public Offerings (IPO). We're on track for a record this year so far with more than $100 billion in IPO's year-to-date, and then next week we can expect the largest single IPO on record in the form of Alibaba at around $24 billion. The second critical variable is on the demand side. I am referring to corporate buybacks, of course, and here we may have the key piece of the puzzle. With more than $300 billion in corporate buybacks so far this year, bullish market strategists should perhaps change their speech from "Don't fight the Fed!" to "Don't fight corporate treasurers!". However, the latest research from Societe Generale strongly suggests a major tone change from this key factor in the future path of stock prices. The chart below says it all, and it's not a pretty picture for U.S. stock prices: