The Probability Of A Stock Market Crash Is Soaring

Tyler Durden's picture

While some individual stocks (cough TWTR cough) may have reached irrational bubble territory, the US equity market is undergoing a seemingly 'rational' bubble. However, as John Hussman illustrates in the following chart, the probability of a stock market crash is growing extremely rapidly.

Based on the this paper, Hussman simplifies the rational bubble as:

You only hold one long one more period if expected return is positive - requiring EXTRAGAIN x (1-p) + CRASHLOSS x (p) to be greater than 0.

As John goes on to explain, The diva is already singing, the only question is how long they hold the note...

Regardless of last week’s slight tapering of the Federal Reserve’s policy of quantitative easing, speculators appear intent on completing the same bubble pattern that has attended a score of previous financial bubbles in equity markets, commodities, and other assets throughout history and across the globe.

The chart below provides some indication of our broader concerns here. The blue lines indicate the points of similarly overvalued, overbought, overbullish, rising-yield conditions across history (specific definitions and variants of this syndrome can be found in numerous prior weekly comments). Sentiment figures prior to the 1960’s are imputed based on the relationship between sentiment and the extent and volatility of prior market fluctuations, which largely drive that data. Most of the prior instances of this syndrome were not as extreme as at present (for example, valuations are now about 35% above the overvaluation threshold for other instances, overbought conditions are more extended here, and with 58% bulls and only 14% bears, current sentiment is also far more extreme than necessary). So we can certainly tighten up the criteria to exclude some of these instances, but it’s fair to say that present conditions are among the most extreme on record.

This chart also provides some indication of our more recent frustration, as even this variant of “overvalued, overbought, overbullish, rising-yield” conditions emerged as early as February of this year and has appeared several times in the past year without event. My view remains that this does not likely reflect a permanent change in market dynamics – only a temporary deferral of what we can expect to be quite negative consequences for the market over the completion of this cycle.



Narrowing our focus to the present advance, what concerns us isn’t simply the parabolic advance featuring increasingly immediate impulses to buy every dip – which is how we characterize the psychology behind log-periodic bubbles (described by Didier Sornette in Why Markets Crash). It’s that this parabola is attended by so many additional and historically regular hallmarks of late-phase speculative advances. Aside from strenuously overvalued, overbought, overbullish, rising-yield conditions, speculators are using record amounts of borrowed money to speculate in equities, with NYSE margin debt now close to 2.5% of GDP. This is a level seen only twice in history, briefly at the 2000 and 2007 market peaks. Margin debt is now at an amount equal to 26% of all commercial and industrial loans in the U.S. banking system. Meanwhile, we are again hearing chatter that the Federal Reserve has placed a “put option” or a “floor” under the stock market. As I observed at the 2007 peak, before the market plunged 55%, “Speculators hoping for a ‘Bernanke put’ to save their assets are likely to discover – too late – that the strike price is way out of the money.”

The following chart is not a forecast, and certainly not something to be relied upon. It does, however, provide an indication of how Sornette-type bubbles have ended in numerous speculative episodes in history, in equities, commodities, and other assets, both in the U.S. and abroad. We are already well within the window of a “finite-time singularity” – the endpoint of such a bubble, but it is a feature of parabolas that small changes in the endpoint can significantly change the final value. The full litany of present conditions could almost be drawn from a textbook of pre-crash speculative advances. We observe the lowest bearish sentiment in over a quarter century, speculation in equities using record levels of margin debt, depressed mutual fund cash levels, heavy initial public offerings of stock, record issuance of low-grade “covenant lite” debt, strikingly rich valuations on a wide range of measures that closely correlate with subsequent market returns, faith that the Fed has put a “floor” under the market (oddly the same faith that investors relied on in 2007), and the proliferation of “this time is different” adjustments to historically reliable investment measures.



Even at 1818 on the S&P 500, we have to allow for the possibility that speculators have not entirely had their fill. In my view, the proper response is to maintain a historically-informed discipline, but with limited concessions (very small call option positions have a useful contingent profile) to at least reduce the temptation to capitulate out of undisciplined, price-driven frustration. Regardless of whether the market maintains its fidelity to a “log-periodic bubble,” we’ll continue to align our position with the expected return/risk profile as it shifts over time. That said, the “increasingly immediate impulses to buy every dip” that characterize market bubbles have now become so urgent that we have to allow for these waves to compress to a near-vertical finale.

The present log-periodic bubble suggests that this speculative frenzy may very well have less than 5% to run between current levels and the third market collapse in just over a decade.

As I advised in 2008 just before the market collapsed, be very alert to increasing volatility at 10-minute intervals.

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Crash Overide's picture

It's a done deal, get out now... :)

Bindar Dundat's picture

This is bullish for tulip bulbs and bitcoins.....

JPM Hater001's picture

I think you meant silver and gold.  It's Christmas after all.  Presents for all holders of metal...

flacon's picture

We had the same conversation this time last year, but S&P was 29% lower and gold was 28% higher. 

JohnnyBriefcase's picture

Yukon Cornelius should be the zerohedge mascot.

knukles's picture

It's just not fucked up enough, yet.

ebworthen's picture

May I say - I love these charts.

johngaltfla's picture

All I can say is that the more f'd up TPTB mess with the futures and options, the more dramatic the crash will become. Hussman is on to something along with the sentiment surveys and bond market (non-govt) manipulation. This has all the makings of a 20% down day at some point next year, a 40-60% not being out of the question over a period of weeks.

GetZeeGold's picture



I don't think the heavy stuff is going to come down for quite some time.


Sure, there's this on Drudge this morning.

Wall Street advisor recommends guns, ammo for protection in collapse...


But other than that......don't really see what the problem would be.

Truthseeker2's picture
Global Financial Architecture and Economic Systems on Verge of Collapse


WordSmith2013's picture


Just what's happening under the radar!


Global Financial And Trading Platforms On System OVERLOAD
GetZeeGold's picture




It's Cloward and Piven.....he learned it in college.


Word is he was on an Arab scholarship at the time.


Pretty sure CNN reported about it. Maybe it was CNBC....I can't remember now.

Winston Churchill's picture

Which college ?

Nobody from his supposed classmates remembers even seeing him.

He is a legend all right, in spook speak.

Headbanger's picture

That's a start but he left out a lot for survival. Like, where are all these urbanites going to "bug out" to with their "bug out" bag or bucket??

People in rural areas will greatly appreciate them for bringing all the food to them!  And rural people are generally a LOT

better armed and trained so aggressive urbanites can expect a "warm" reception out int the country side.

Another thing is sand bags protect you not your loaded weapons as they are for offensive and counter attack actions.

And how about training!!??   Most people buying a firearm for "protection" never shoot with them and thus would be dead

in a combat situation when they have that first "limp wristed" failure to eject jam and panic trying to clear it. Especially

with a never fired semi automatic. So get a revolver if you're not going to practice a lot but then you better practice

rapid reloads. But you better be sure the expanded spent casing eject easily from the revolver cylinmder .

The there are the not so little issues such as actually having to hit the attacker and stop them.

So yes, have a bug out bag, a revolver, a GPS, And go to your nearest Civil Defense Shelter.   Oh wait...

New England Patriot's picture

Best just to report directly to the Super Dome.

NickVegas's picture

Stop it, I can't breathe. I say f it, I'm doomed, I'm fumbling my reloader, while people are shootin at me. My plan, and it is in it's infancy, is to just stay drunk for long periods of time. I took a trip to Vegas one year, and spent 5 days drunk. I had a beer in my hand every waking moment. I have pleasant memories of that trip. The craps dealer at the clown casino hit me in the hand hard for doing my patented straight six set. I could just turn it to like "Days of Wine and Roses". So, I'm guess I'm confessing, my plan is to become an alcoholic, and hopefully people who can handle battle reloading will prosper. That will be the decider, who can reload in battle. It's just weirder and werder. How weird can you stand it, before your love cracks? 

Keyser's picture

Perhaps, but the 10 year rate wasn't climbing through 3.0% last year. 

Panafrican Funktron Robot's picture

Indeed.  I'm looking at a chart that basically is tracking the money supply.  It should be noted that said chart also looks a lot like the early stages of hyperinflation.  

CognacAndMencken's picture

If you're looking at money supply, you're being misled. Every metric that measures inflation is showing little to no inflation concerns whatsoever.

The parabolic increase in money supply is, mostly, just excess reserves held by member banks at the Fed. Before the crisis, excess reserves were normally ~$10B or so. Now it's nearing $2T, which accounts for that scary parabolic chart of money supply that you're referencing. That money is just sitting there, earning a measly .25% and keeping the system liquid and well capitalized in case another deflationary buzz saw threatens to cut all assets in half again. All that excess liquidity backing up the banks' balance sheets is like having the worlds largest fire truck full of water parked in front of a known fire danger. If/when it's ever needed (like it was in 2008/9), it's there; until then, nothing's getting soaked. Gold and TIPS and the entire bond market are signaling that inflation is NOT a threat.

chubbyjjfong's picture

Couldn't agree more.  Money supply is only increasing for the 1%ers. Banks are not lending to the working class coutesy of ZIRP. Therefore money supply for the working class is dramatically decreasing. The FED is printing 75 bill a month to try and replace that lost money creation. Its only going to the 1%ers so in actuallity we are seeing 75 bill transferred from the working class to the elites every month. That increased money supply, offered on a platter to the elites, is being spent on luxury goods, high end real estate, art, and equity's. That is where the inflation is materializing. For all else apart from, fuel and food, deflationary forces are increasing. Wages are stationary at best. This equity bubble, along with all other luxury commodities, is likely to continue in conjunction with continued money printing. Where else can the money go? 

Is there something external that will trigger the masses into an awkening state. Not likely when they do not even know or care what is happening to them as a result of this economic system. When you understand that tax and jobs are irrelevent in this money printing environment you can appreciate that this bubble can absolutely continue. The working class are being controlled by jobs and taxes. What is the alternative however? I have asked myself that question many times and I cannot find an answer. Its shoot the moon or nothing unfortunately.

derryb's picture

Is there something external that will trigger the masses into an awkening state?

Rising Interest rates will be the game changer.

CognacAndMencken's picture



What makes you think interest rates will rise? Since 1981, rates are on a 33 year trend toward ZERO.  As the supply of money increases, the competition for yield increases; as the competition for yield increases, the cost of money zooms toward zero with a few ups and downs along the way.  

Ask yourself, why was the 30 year mortgage 20% in 1981 and 3% 30+ years later? Why do you think banks are always encouraging you to "lock in your low rate NOW!"  They've said that every year for the past 20.. lol...  Do you really think banks want you to get the lowest rates?  NO!  They want you to pay the highest possible! Banks know that rates will slowly move to ZERO basis points over time, so they want you to lock in a 30 year contract with 450 basis points while they can still trap you.  Sure, rates might rise a bit, touching 5% or 6%....  but not for long, maybe a year or two... a very small fraction of your 30 year contract.  If you're not on a tight budget and you can withstand some temporary increases, the smartest thing you can do is sign a variable rate, 30-year mortgage that tracks the 10YR.     

If you believe in inflation -- meaning that money becomes less valuable over time -- then you must surely believe that the cost of money becomes equally less valuable over time.  If money becomes increasingly worthless, how can you charge more for it?  You can get away with it in the short run, but not the long run.  

Rates are going LOWER.  Few bumps, here and there.  But LOWER, over time.  I've got a 33 year chart to prove it.  

SAT 800's picture

With regard to the 33 year chart; the past is no guarantee of future results.

eclectic syncretist's picture

That 33 year chart you've got proves another thing; rates have broken out of the 33 year trend to the upside.  You might ask yourself, it the power hungry sociopaths in charge are going to make one big money grab from the commoners, what would higher rates do to help them steal you and your neighbors money?

TheReplacement's picture

And where were rates 40 years ago?  33 years does not forever make.

SDShack's picture

Rising interest rates are the game changer... so that is why TPTB will never allow it to happen. They have learned from the Euro fiasco and won't let the bond vigilantes do that again. That is the real reason why the Fed is slowing controlling the bond market. It is why they now control about 1/3 of the market. It will be game over for the bond vigilantes when the Fed controls 51%. Federal budgets can explode to keep the FSA happy. Deficits won't matter because the Fed is just monetizing the debt. TPTB have gamed the system to pump and dump to take whatever assets are still held by the middle class. The sheeple are content to just have any roof over their head and SNAP cards in their wallet. The New Feudal World Order is coming Fast & Furious and the serfs are actually encouraging it. 

shinobi-7's picture

But eventually it must stop. Japan is much more advanced on that curve and half the country is now hollowed up. Soon (means in 2014) real inflation will pick up. We can already see it in the stores but the acceleration will be stiff. The 3% VAT rise in April will have an instant impact as will the devaluation of the Yen. Monetary instability of course has the opposite effect on the dollar as the last resort reserve currency but it is all based on trust and when trust goes so does the currency. So yes the music can go on for a while but not forever as for the "musicians", they will not stop "playing" but nobody expect them to anyway.

savagegoose's picture

so the fires are going to burn, they   open up the taps on the truck and all that liquidity is used up to douse the flames. What then? we're fresh out of liquid and more QE?

Ned Zeppelin's picture

The best part is that "money" earning .25% was merely swiped into existence, not earned, and thus the interest is a gift. I always figured the excess reserves would be deployed to buy Treasuries no one wants, as a sort of deranged variant of QE.

stocktivity's picture

...actually the same conversation for 5 years - It's all Bullshit!

Freewheelin Franklin's picture

Tulip bulbs is, maybe, the only place your money is safe. There and apple jack. 

Dazman's picture

And yet, the probability is still under 50% according to this chart.

JPM Hater001's picture

3 Oz Silver on that?  I'll take 3:1 90 days.

The Mist's picture

To be honest I'm not sure what to make of these charts, they pop up on ZH a couple of times every month, predicting a collapse of some sort, and then nothing happens.

In fact, the inaccuracy of these charts almost makes me believe all is well...

Dazman's picture

The truth is, everyone that is calling for a collapse is right. The problem is, nobody really knows the timing. Unfortunately, timing is everything. "The markets can remain irrational for longer than you can stay solvent".

Another favorite quote of mine is from Peter Borish in the Paul Tudor Jones documentary "Trader". To paraphrase... "You can't just stop a train. It will crash through a wall and keep going before it stops". I.e.

Rubbish's picture

Honey we shouldn't have gone vacationing in Aspen this year, such a hassle to replumb the house. Probably time for us to move?


Tic toc, tic toc

Freewheelin Franklin's picture

"You can't just stop a train. It will crash through a wall and keep going before it stops".


Sounds like Obamacare

eclectic syncretist's picture

A widespread expectation of another $10,000,000,000 taper at the January 28-29 Fed meeting could be enough to crash the market.

In January 2000 it was the fear that interest rates would rise that led to a market collapse, when in fact Greenspan ended up lowering rates to counter the fear, but he was already too late and the nasdaq went from over 5,000 to 1,100.  It has happened before.

moneybots's picture

"In January 2000 it was the fear that interest rates would rise that led to a market collapse, when in fact Greenspan ended up lowering rates to counter the fear"


Greenspan was raising the FED rate in 2000, then stopped at 6.5%, prior to the Presidential election window of FED neutrality.  At the beginning of January 2001, Greenspan made an emergency rate cut of 1/2%, followed by another 1/2% at the January FED meeting.

The economy was fast approaching a recession.


ebworthen's picture

The Mist said:  "In fact, the inaccuracy of these charts almost makes me believe all is well..."

Precisely.  South Seas shares can only go up, and Black Tulip bulb values will never go down.

Bubbles require the confuzzlement of a reality that defies reality, and a frenzy to "not miss out".

It's just a matter of time, and if you can time the next crash you'll be rich; or broke if you can't.

OldPhart's picture

If I hadn't listened to Zero Hedge I'd have made 35% this year on my 401-k in stead of 25%.

Shit happens.

GetZeeGold's picture



Keeping it is going to be the tricky part.

Dapper Dan's picture

"Being a language, mathematics may be used not only to inform but also, among other things, to seduce."

Financial markets are the machines in which much of human welfare is decided; yet we know more about how our car engines work than about how our global financial system functions. We lurch from crisis to crisis. In a networked world, mayhem in one market spreads instantaneously to all others—and we have only the vaguest of notions how this happens, or how to regulate it.

So limited is our knowledge that we resort, not to science, but to shamans. We place control of the world's largest economy in the hands of a few elderly men, the central bankers.

Benoît Mandelbrot

The (Mis)Behavior of Markets


Shooting Shark's picture

What would be interesting is the same data from the charts in this post along with some perturbations in the supposedly predictive chart (log something of Jan 2014) and a fit test to compare how, say, failures in December and February match compared to failure in January.  Or 2015.  Or never.

Instead we get charts with real data sourced from somewhere, imaginary data from somewhere rather more local, and then a lurid up or down SINGULAIRTY arrow drawn like a big ol dick on a concrete wall, just to make sure we get the point.


There's a lot of good stuff here.  There's a lot of crap, too.  And most of the crazy-hate is confined to the comments, except when that anti-semitic commie loon "George Washington" is posting.


(Edited for minor typos)

max2205's picture

I am pretty sure no crash will or could happen with 6 billion fake Fed Pomo entering the market every month

pavman's picture

Not to mention circuit breakers.  Derp.

Freddie's picture

We are in full on Zimbabwe territory.  I knew when Obam was "elected" that he would be Mugabe 2 but hoped I was wrong.   Nice job Democrats,