Guest Post: Diminishing QE Returns And The Coming 40% Correction

Tyler Durden's picture

Submitted by Chris Martenson of Peak Prosperity blog,

Warning: Stocks Likely To Crater From Here

I don't relish the job of constantly pointing out the risks to the equity markets. But since few on Wall Street seem willing (or able) to do this, I'm "making the call" for a market correction, as enough variables have aligned to indicate a high likelihood of stocks heading downwards from here.

I've only given one other such warning about equities before, and that was in March of 2008, when I warned of the possibility of a 40% to 60% decline in stock prices by Fall. I am making a similar call today, with the understanding that I am usually a bit early to the game with my views.

Before I get into the details, the broad outline is that I see a case where speculative fevers, propelled by the Fed's $85 billion thin-air money printing program, have more or less run their course, with the Dow and S&P indexes stalled near their all-time highs. That is, $85 billion a month is what it takes to merely keep the Dow near 14,000 and the S&P 500 near 1,500.

On a fundamental basis, I see numerous signs of consumer weakness, political in-fighting and paralysis in DC, high insider selling, and the return of the retail investor (a.k.a. "greater fool") to the stock market. 

On a technical basis, there are numerous tell-tale signs of a market top, including too much bullish sentiment, waning momentum on multiple timeframes, and too many NYSE stocks being above their 200-day moving average (at least until recently; that's begun to correct).


Triple Top?

The S&P 500 and Dow Jones are both once again near all-time highs…for the third time.  The old saying third time’s a charm can work both ways when it comes to the stock market.  Sometimes an index will bust through to new highs, and other times it will fail spectacularly crashing to new lows.

We should all be watching the behavior of the major indexes here, because the possibility of a major triple-top failure is quite high, for reasons outlined below.

If the S&P 500 fails at the triple top and breaks down, from a charting perspective the next thing for it to do is revisit the bottom and then make up its mind as to what it wants to do next.  The implication here is that a major failure of the S&P 500 will open the possibility of it revisiting the 600-800 level, or some 45% to 60% lower from the 1,500 level where it currently churns.

It will take some time to get to that level, typically 3-6 months, unless there’s some sort of financial accident to hasten things along, in which case it could all be over in a month or two.

Assuming a failure at the triple top, we’ll just have to watch and see what the market wishes to do once it plumbs the bottom once again.  For now, the daily and weekly charts of the S&P 500 show waning momentum, and the weekly chart remains in overbought territory (green lines and circles):

These overbought and slumping momentum indicators are headwinds to the Fed’s efforts to keep the stock market elevated. 

From a historical standpoint, stocks are cheap when they sport a collective p/e in the high single digits.  Currently they are anything but cheap on that basis. 


With a current p/e of 22, the S&P 500 is on the expensive rather than cheap side of things, and is roughly 35% above its long-term average and more than 100% above what we could legitimately call 'cheap.'

The summary here is that if stocks do indeed retreat from here, a triple-top failure will deliver quite a punishing blow to the current efforts to repair the public’s trust in the stock market as a place to send their hard-earned savings to grow.  It would be quite difficult to engineer a run at a fourth top, given the importance of retail participation in providing fuel for the rise of stocks especially given that the boomers are retiring at the rate of 10,000 per day and drawing upon their investments instead of adding to them.

The younger generation(s) have been the main victims of the high unemployment and general wage stagnation that have been the hallmarks of the Great Recession.  It is not likely that they will be able to save and invest at a rate equal to the boomer's withdrawals, creating one more equity headwind for the Fed to overcome.

Sell in May and Go Away

Of course, another old adage that applies to the stock market is sell in May and go away, which has proven to be a remarkably effective strategy over the years.  The average return between May and September is -0.5%, while it is over 12% for the rest of the year.


Why this yearly vacillation of returns occurs is open to speculation, but a betting person would have to think long and hard about buying stocks here with May approaching and the Dow and S&P at all-time highs rather than staying on the sidelines and then buying back in September or October if one was so inclined.

However, given the macro forces at play at this time, this May-to-September period could easily offer much more dramatic losses than 0.5%.  I am personally thinking as much as two full orders of magnitude greater, as -50% is right in the middle of my target window for losses.

As always, the best time to begin repositioning one’s portfolio is before any big moves get underway, so I personally would not wait until May to make adjustments, assuming one was of a mind to do so.

Whether or not you forego selling stocks, lighten up your positions, or take on some form of portfolio protection in the form of puts or inverse ETFs, these seem like good things to do before April is over.

Danger Ahead

Technically stocks are overbought. Fundamentally, the picture is even worse: they are facing a litany of economic drags (including weakening GDP growth, higher taxes, the impact of Obamacare, sequester cuts, high gasoline prices, chronic unemployment, etc.) and robust insider selling.  We explore these fundamental risks and their likely impact in great depth in Part II.

For all of these reasons, equity markets face a very high chance of falling over 40% between now and fall of 2013.  (Yes, I'm aware of how extreme a price prediction this is.)

While there’s always a chance that the Fed can keep things magically elevated and they’ve done a very good job so far –  it is my view that they cannot do this for much longer without a serious correction to justify an even larger program of overt and covert intervention. 

In Part II: How the Market Failure Will Happen, I detail how the pattern I expect to see will play out and why I expect the fall in equity prices to happen within the May-September window.  This downdraft will be characterized by lots of volatility, formed by market routs and Fed-inspired rescues, alternating until some form of bottom is reached.  Along the way there will likely be a flight for "safety" into the dollar and Treasury paper, but only during the first stage of the next crisis.

Once a bottom is reached again, this might be anywhere from 40% to 60% lower than the current ~1500 level on the S&P 500 the process will begin to be dominated by rising government borrowing, which will cause interest rates to begin to rise. 

When that happens, expect capital to flee the paper market for hard assets.  In particular, that's when the upwards price revolution in the gold and silver markets will kick into high gear.

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francis_sawyer's picture

So does this mean that Prechter is going 400% short or is he up to 800% now?


Calling a "DREADED TRIPLE TOP" is like paying for a football tout service & getting the valuble advice that the KICKOFFS will be at 1PM for east coast games & 4PM for west coast games...

Dr Paul Krugman's picture

Doomers have been saying stocks would fall since they bottomed.  Bernanke is finally setting the stage for a recovery and doomers and gold bugs (not sure if there is a real difference) are still yapping about the end of the world.

TruthInSunshine's picture


Robotrader, say what one will about him, but he invited me out on his Yacht, "iNail Tops & Bottoms," which was very gracious of him.

Dr Paul Krugman's picture

The fact that I take time and write with you shows that I care; I want what is best for this country, and the world, and I think that my ideas have proven to be accepted across this great land.

geminiRX's picture

You forgot the, "Now where is my burger and fries bitch"

dark_matter's picture

Paul, just knowing that you care brightens my hum drum existence. It's like a big virtual hug that sends a giant tingle up my leg. Can't thank you enough.

thruid's picture

Mr Krugman,

Despite evidence of systemic fraud there has not been a real investigation much less a prosecution for fraud involving any of the TBTF banks.  Instead there have been a few fines which are a fraction of the profits made by the banks involved which have no personal consequences whatsoever for the individual which committed fraud.  Instead,  the loses from fines are felt by the shareholders.   With the financial industry funneling hundreds of billions into campaign coffers over the last decade I don't expect there to be any prosecutions.  In sharp contrast, retirees that have worked hard, lived a frugal lifestyle, and saved their entire lives are now crushed by ZIRP. There has been a recovery, but I would argue that it has been a recovery for the wrong group of people.

Accepted and correct are different things.   Time will tell.................. and history can be a very harsh judge.  

jmcadg's picture

Seriously Krugman, is there anyone more deluded in this world than yourself, and arrogant 'I think that my ideas have proven to be accepted across this great land'.

Someone take him to a home for the retarded, please.

Squid-puppets a-go-go's picture

The fact that your ideas have been accepted across this great land is precisely why everyone is going over the cliff together

Col_Sanders's picture

Your ideas have proven many things.

Primarily how stupid and gullible most people are. 

Enjoy it while it lasts.

If there's any justice at all in this world, then there will be a special place in hell for people like you.

akak's picture

Gideon Gono gave the Zimbabwean stock market quite a 'recovery' as well.

I think it's fair to say that the average Zimbabwean, however, saw more 'doom' than 'recovery' in the associated 12,000,000,000% inflation.

Oh, and by the way, it is only the diehard pro-status-quo, pro-Establishment Quislings such as yourself, "Doctor", who prattle on about "the end of the world".  That is a strawman which exists only in your own terminally ignorant, and terminally dishonest, minds.  Although, to be fair, the end of the current corrupt and unsustainable financial and monetary paradigm might just be the end of YOUR world of sociopathic priviledge and abuse, though.

Dr Paul Krugman's picture

Inflation is low and has been for years.

LibertarianX's picture

Define inflation...... 


Bitch !!






Beam Me Up Scotty's picture

Come on Krugman.  LibertarianX is schooling you in the school of economics.  Define inflation.  Thats the key isn't it.  You just change the equation, to suit your needs.  How can you say there is no inflation?  In 2000 gas prices were hovering near $1 a gallon.  Today, 13 years later, they are near $4 a gallon.  No inflation?  Food costs more, or the container size has shrunk.  Things aren't built to last, they are built to fail.  Cars today are junk compared to the late 90's.  Even if the cost stays the same but something lasts half as long, thats 100% inflation right there.

For being a Doctor, you sure are stupid.  But I had a roommate in college who was a 4.0 student, and yet he couldnt figure out how to put a drill bit into a drill.

akak's picture

If by "low" you mean at least 5% on a REAL and annual basis, then we can agree.

Funny how "inflation" (but let's call it what it really is: government abuse and depreciation of the fiat currency) was never a problem under the gold standard.  Nobody then had to worry that their savings would be worth less each year than the one before.

SunRise's picture

Low inflation over many years is a disaster.  I want DEFLATION, because having a lesser job or no job at least means I'll pay less with the little there is left. 

The key issue is not inflation, but whether any other human has a right to use your labor for their purposes, i.e. slavery.  Dollars are a claim on my labor.  When they are inflated, my purchasing power evaporates and my labor has been stolen.

When the government "spends" my life for their purposes, I am a slave - No Thanks!  I'll keep my change if possible!

winagain's picture


Don't mention the dreaded" D " word

The " D " word is more awful then the F_ _ _ word

Seems logical  lower priced goods and services would sell in higher quanities

The debt cartel short circuits when the dreaded "D" word applies

Winston Churchill's picture

They have little "blue pills" for that.

No Euros please we're British's picture

I take it, you're not a fan of "shadowstats"? You really think that the inflation figures are not being manipulated? They sure are in the UK. I'd say true day to day living inflation is running at around 8% pa. Who would have thought the government would manipulate the RPI/CPI data. Although you might wonder why there would be 2 different  measures to describe the same thing.

eXMachina's picture

Dr. Krugman with all due respect, the CPI has been low ie. the published figures. Any consumer on a regular income paying for anything from utilities, gas at the pump, groceries and just about anything else will tell you that prices have soared and packaging has got smaller. Real inflation is in double digits. To ignore this reality you have to be either one-eyed or have an alternate agenda. You're clearly and extremely intelligent human being and for this one has to assume it's the latter.


Whizbang's picture

well, my grocery budget has doubled this year for the same items, and housing in d.c. has increased 50% in the last year so I can't agree with you on this. If you mean to say that the heaviliy manipulated CPI data shows low inflation, than that is another thing altogether, but This figure is cherry picked to keep social security payments at an 'ahem' sustainable level.

HowardBeale's picture

Bernanke just--over the last two days--proudly announced to congress he's managed to inflate real estate prices, for example. Though perhaps that is another of those irrelevant expenses like food and fuel...

winagain's picture

Mr. Krugman

Please adjust CPI  for packaging variance

Same package less:

ice cream




Similiar to the USD (dollar) same size note but no buying power!


WhiteNight123129's picture

Which year? 1971? Or 1946? or 1937?

You and I know what this regime is, it is not different from what Henry Thornton warned about. An indefinite rise in credit due to repressed cost of borrowing. If we extend credit faster than income this time we will have weimar. Democracy does not tolerate to adjust credit through bankruptcy so it adjusts it through monetary dilution.

And not everyone is a scrooge McDuck. Some people have fixed annuities and worked for those.

Monetary base is expanding to fight deflation, but are you telling us that after we get out of this deflationary forces, the fed will unwind the monetary backwards for the first time since 1933?

Are you telling us that the US will do a McCulloch contraction?

If not and if you maintain that monetary base has no impact on price levels once the credit deflationary forces are gone, please ask to have your compensation indefinitely frozen at 1.5 % increase for the rest of your days, put your money where your mouth is.


Thalamus's picture

Gasoline is double since Barry took office, health insurance and college tuition have double digit increases every year, food prices have to be close to double digits, but luckily cat food is being shorted by Bernanke to keep the senior citizens fed.  

johngaltfla's picture

Unless you eat, use gasoline, health care insurance, go to college, use electricity, shit in a toilet and not an outhouse, take showers, wear clothes, get a haircut, and most importantly, pay taxes, you are 100% correct.


Did I mention that anyone with the last name of Krugman is a lying asshole lately?


If not, there's your reminder.

chump666's picture

Is this the real Krugman?  Seriously.  Are you him?

Whizbang's picture

Normally I don't get caught up in these, but if you honestly are comparing the worlds #1 superpower with a third world, pre industrialized nation, it means you have a fundemental misunderstanding of finance. The u.s. can't have inflation that high without obliterating the financial markets of the world. Oil, gas, and other commodities are in dollars and the currencies of many nations are kept pegged to the dollar, so any strongly inflationary move will lead to a cool down and mild deflation, a la 2010.

akak's picture

"It can't happen here!"

Where have we heard this before?


PS: Your faith in existing authority and the status-quo financial and monetary paradigm, no matter how corrupt and unsustainable, is touching, if frightening.  But just keep telling yourself "It can't happen here, it can't happen here".

WhiteNight123129's picture

It is like saying reserve currency never changed in the history of the world. The medium of circulation is just that, if the medium fail people find another one promptly and go by their affairs. They do not really care what the medium is, but do care about the exchange part. So dump the medium, use something else and move on. No bid deal. (I live outside OECD, if the commodities already paid in Yuan are more paid in Yuan so what?). Who care is some emerging nations use more Yuan and less dollar? I don´t.



thruid's picture

So, I gather what you are saying to the author of the peice is that....................   ' you don't buy his premise and it is a pretty unlikely possibility ' ??

winagain's picture

Mr. Krugman

I read your articles quite often.

I agree the 2008 train wreck is over IF our currency (and other world currencies) really is just monopoly money (like the game).

If the crisis was really over every central bank, economists, fed member past and present would not spend time talking about the current situation

I would buy your spending message if during good times budgets were balanced ect. Debt fueled most growth around the world.

This world is on life support:

Resumed mark to market accounting- not

Debt and deriviatives have been cleared- not

Europe and the US have restructured their fake economies (government spending)-not

Fed has stopped buying US debt / ponzi- not

Fed has stopped providing liquidity to the primary dealers / Europe through primary dealers-not

Banks now carry the mortgage market instead of the Fed -not

How many points should I make

The current goal is propping up the debt cartel ( Money center banks) and the derivative web holding the world economy hostage!!!!

This crisis will not end until the derivatives are unwound and debt restructured


WhiteNight123129's picture

I am not a doomer, like you I cherish inflation.

Gordon Freeman's picture

Amen, Francis!

"Big light in sky scheduled to appear in East"  Fuck Chris Martenson's drivel!

subqtaneous's picture

when it comes to CM, yep: recall the 'everyone grab your shit and run for the hills!! . . . this is the BIG catalyst' nonsense after the Japanese tsunami?

Groundhog Day's picture

Blah blah blah....Bernanke has got ours backs.  Just BTFD and put your head back in the sand, you'll feel better.

HD's picture

I have not read this yet. I'm just going to take a moment and assume the title is true.  I need a big ol' unicorn hug today.

maskone909's picture

i read it. i need a mouth hug.

McMolotov's picture

I got a warm and fuzzy feeling, but that's probably because I pissed myself and fell on the dog.

Zap Powerz's picture

You have to have balls of steel or be a masocist to come to ZH regularly.  This place will tear your reality apart if youre not used to it. 

I wonder how many people find this wonderful site, start reading and after a few weeks 1) commit suicide, 2) their head explodes, 3) they start drinking heavily(er) or 4) they go to Washington DC or Wall St heavily armed and go on a righteous rampage.

My reaction to this site was number 3.  I dont have the balls for 4.  I hope someone does.

fonzannoon's picture

I was on number 3 before i got here so Zh fits like a glove. the hard part about zh is understanding it is 100% correct but it sets your brain up to constantly look for an asterioid to hit while you barely notice you are standing in quicksand.

Beam Me Up Scotty's picture

I find myself drinking more red wine these days.  Damn there are some good vintages out there.  I like a fine cut of New York strip to go along with it hot off the charcoal.  I figure I am not going to make it to my later years, so I am going to start enjoying the hell out of the time I have left. 

I'll drink to that, Zap, and Fonz.


francis_sawyer's picture

secret to those things is:


- let set to room temp [& give nice pinch of salt & pepper]

- cook on scalding hot iron griddle [preferably ribbed]

- add touch of butter upon completion

- let REST 10 min before eating



maskone909's picture

"it was on the tip of everybodies toungue, Tyler just gave it a name." so when is the first ZH meet? vegas?

CrimsonAvenger's picture

Yeah, #3 is is a favorite. We counsel against the others as they hurt ZH on repeat traffic.

McMolotov's picture

#3 for me, and too much of it to competently pull off #4.

lickspitler's picture

a bullish view is just for the sheeple , non stackers who just can,t see it ,or just don,t understand how it really works. they have made a real killing however, the fucktards