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	October Crash Redux?   (October 4, 2005) One reader reports that every time she reads one of my financial entries, she gets an urge to jump out the window. Yes, I know I write about evidence for a doom-and-gloom outcome to this era's bogus "prosperity," but I am not the only one. In general, the press is rather more skeptical of a bright prognosis for the U.S. economy than the financial industry--the big brokerage houses--who are of course eternally optimistic. It's always a good time to buy stocks of some sort, or better yet, cash out of one sector and move the money into another, and thus generate two commissions instead of one. Compare the bullish bias of Smith Barney's top U.S. equities analyst, Tobias Levkovich, with Barrons magazine's run of skepticism. While hardly a bastion of anti-capitalist fervor, Barrons' columnists and technical analyst are bluntly wary of U.S. stocks and the prospects for the usual fourth quarter run-up. Nobody is predicting an October crash similar to the one which caught everyone by surprise in 1987, so allow me the honor. Let's compare some very basic factors which underpin a bullish market heading for the stars. There must be lots of free cash sloshing around which can flow into stocks. Stocks are like anything else, subject to supply and demand. If there's demand, the prices rise; if there's too much supply and few buyers, the price falls. Levkovich is aware that he has to come up with some huge sources of cash in order to support his bullish claim, and so he stretches out, way out, to dig up some arcane measures of liquidity to show us that there is money around, but unfortunately we can't see it directly--it's in hedge funds and foreign hands. But instead of trusting his fancy-footwork, let's look at sources of cash we can measure reliably: the amount of cash sitting in mutual funds, and the amount of borrowing power sitting in stockholder's margin accounts. (Margin is a loan which brokerages extend based on the value of your portfolio.) According to Barrons, mutual funds are holding a mere 3.9% of cash, far lower than the 8-10% which they've held prior to market runs. Margin debt is currently an enormous $208 billion, compared to only $83 billion ten years ago before the great bull run began in earnest. Even more damning, the source of cash Levkovich is counting on to fuel his 15-month bull market is classic "hot money"--money that spins in and out of "investments" with lightning speed. That's hardly the basis for a sustainable bull market. In true contrarian fashion, markets rise from skepticism and doubt, not from bullishness. The psychology runs thusly: if everyone is already bullish, then there's nobody left to buys stocks and drive the prices higher. So of course Levkovich claims that doubt and fear are everywhere, thereby setting the foundation for his claim that stocks are set to rise significantly over the next 15 months. But again, let's look at more trustworthy numbers. According to Barrons, Investors Intelligence Poll of Bulls/Bears is currently 53.2%/26.6%, compared to a ratio of 31%/50.9% ten years ago. Note that the numbers are exactly reversed: before the great bull run of 1995, 50% of investors were bearish--the perfect contrarian setup. Now investors are 53% bullish, a perfect bearish setup--yet Levkovich sees only blue skies and another 15 months of bullish upside. Are we touching the elephant's trunk while he feels the tail? It would seem so. Markets rise as profits rise; historically, they rise when PE ratios (price to earnings) are low. Currently the "Forward P/E" of the Dow Jones Industrial Average is 18--not bubble-era (25) but not a bargain, either. Ten years ago, it was 13. At real market bottoms like 1983, it was 7. Bull markets don't run from four-year highs. U.S. markets are within 2% of their 4-year highs, while non-U.S. stock markets in Asia and Europe are hitting all-time (post-2000 bubble) highs. Let's see: Europe is barely above recession, Japan is staging a very modest break from 15 years of decline, oil has nearly doubled in less than two years, there's an unprecedented global housing bubble (see above chart), and that's wonderful enough to goose global markets to new highs? Skepticism would be a natural and healthy response to this sort of poorly anchored euphoria. Markets are chaotic systems, and are prone to sudden sharp declines and spikes up. Just because global markets have been calm since 9/11/01 doesn't mean that risk has vanished. (Please see Is Risk Being Eliminated or Merely Increased?, Doubling Down on 5-Card No-See-Um, and the other essays under "Financial Meltdown Watch" in the sidebar to the left.) So allow me to posit the unthinkable: the markets are poised not for a 15-month run up to new and giddy heights, but for a sudden, sharp drop of 10% to 20% this month. There, I said it. Let's see if thunder rumbles and lightning strikes. * * * copyright © 2005 Charles Hugh Smith. All rights reserved in all media. I would be honored if you linked this wEssay to your site, or printed a copy for your own use. * * *
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