It’s Feeling A Lot Like 2007 - Are You Prepared For The Next Crash?

July 24, 2017

It’s Feeling A Lot Like 2007 – Are You Prepared For The Next Crash?

  • There’s nothing to worry about. Everything looks exactly the same as it did in July 2007 when no one was worried because the S&P 500 was breaking new highs.
  • Even the statements from the FED’s 2007 chair and the chair of it today look alike.
  • This doesn’t mean there will be a crisis in 2018, but it sure means you have to be prepared for anything.

Introduction

Last week I published an article describing how strong the trend is that is pushing the S&P 500 higher. There is plenty of liquidity, corporations are doing big buybacks, and most investors are putting their money into passively managed investment vehicles.

The current situation, after almost 9 years of economic growth, has made investors complacent about what’s going on in the economy and in financial markets. However, complacency in financial markets is similar George Foreman being tired in the Rumble in the Jungle fight against Ali. Thus, there is a high probability that it won’t end well.

The goal of today’s article is to give some food for thought. I’ll compare the situation we’re in now with was happening in July 2007.

Exactly 10 years ago, the S&P was breaking new highs.


Figure 1: S&P 500 in the last 10 years. Source: Yahoo Finance.

When the stock market index reaches new highs, it means that the economy is doing well and everybody is pretty positive about what will happen tomorrow. Corporate earnings are usually on the rise and there is plenty of liquidity in the system. As I mentioned above, such an environment makes investors very complacent. But let’s compare the current environment to the environment in July 2007 when investors felt complacent as the S&P 500 was breaking new highs.

A look at S&P 500 earnings shows that in July 2007, the chart was looking even better than it does today as there were 5 years of constant earnings growth. Compare that to the current situation where earnings have been mostly flat for the last 5 years.


Figure 2: S&P 500 earnings. Source: Multpl.

A look at the unemployment rate shows that the 2007 unemployment rate and rate today are perfectly correlated.


Figure 3: U.S. unemployment level. Source: FRED.

Consumer credit was at historically high levels in 2007 and nobody was concerned about it, pretty much like now.


Figure 4: Consumer credit. Source: FRED.

Our interest rate is rising, just as it was beginning in 2004.


Figure 5: Federal funds interest rate. Source: FRED.

Given that the interest rate has been seeing lower highs and lower lows for the past 35 years, it doesn’t look like it will reach the highs reached in 2007 before it inflects again.

Another interesting comparison between now and 2007 is the amount of stocks bought on margin. It is, of course, at an all-time high just as it was in 2000 and 2007.


Figure 6: Securities market credit. Source: NYSE.

Now, I could add another 20 images of similar economic and financial data that show how similar the situation looks to 2007. However, I’ll finish with the comparison between what Ben Bernanke, the former FED chairman, said in 2007 and what Janet Yellen has said recently.

U.S. Federal Reserve Chair Ben Bernanke, May 17, 2007:

“We believe the effect of the troubles in the subprime sector on the broader housing market will be limited and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”

U.S. Federal Reserve Chair Janet Yellen, June 27, 2017:

“Would I say there will never, ever be another financial crisis? … Probably that would be going too far. But I do think we’re much safer, and I hope that it will not be in our lifetimes, and I don’t believe it will be.”

So given that even what the former and current FED chair people were and are saying is similar, much of the financial and economic data resembles, and most investors are feeling complacent as they did in 2007, we could feel the same today and just continue to do as we are doing.

I apologize for a bit of irony here, but I find irony the best way to describe what is going on.

The above data doesn’t mean there will be a stock market crash starting at the end of 2017 and then continuing into 2018, although that is a possibility. The point of the comparison is to warn investors about the risks of investing along with the complacent herd.

No one knows, not even Janet Yellen, when the next recession will come as the factors that will trigger a recession are still unknown. It will only become clear that the economy is in a recession, and what triggered a recession, after it has already happened.

It’s important to recognize that the financial metrics looks the same as in 2007. Thus, the stability of the financial system isn’t that robust – or better to say “anti-fragile,” to use Nassim Taleb’s way of looking at things. Therefore, the best thing to do is to be prepared for anything as we never know where the shock will come from that will trigger the next recession and bear market.

Keep reading Investiv Daily as we continue to analyze the markets in order to find the best positive asymmetric risk reward exposures for your portfolio.