Jim Rickards Warns: Bursting This Bubble Could Break The World

Authored by James Rickards via The Daily Reckoning blog,

The key to bubble analysis is to look at what’s causing the bubble. If you get the hidden dynamics right, your ability to collect huge profits or avoid losses is greatly improved.

Based on data going back to the 1929 crash, this current bubble looks like a particular kind that can produce large, sudden losses for investors.


The market right now is especially susceptible to a sharp correction, or worse.

Before diving into the best way to play the current bubble dynamics to your advantage, let’s look at the evidence for whether a bubble exists in the first place…

My preferred metric is the Shiller Cyclically Adjusted PE Ratio or CAPE. This particular PE ratio was invented by Nobel Prize-winning economist Robert Shiller of Yale University.

CAPE has several design features that set it apart from the PE ratios touted on Wall Street. The first is that it uses a rolling ten-year earnings period. This smooths out fluctuations based on temporary psychological, geopolitical, and commodity-linked factors that should not bear on fundamental valuation.

The second feature is that it is backward-looking only. This eliminates the rosy scenario forward-looking earnings projections favored by Wall Street.

The third feature is that that relevant data is available back to 1870, which allows for robust historical comparisons.

The chart below shows the CAPE from 1870 to 2017. Two conclusions emerge immediately. The CAPE today is at the same level as in 1929 just before the crash that started the Great Depression. The second is that the CAPE is higher today than it was just before the Panic of 2008.

Neither data point is definitive proof of a bubble. CAPE was much higher in 2000 when the dot.com bubble burst. Neither data point means that the market will crash tomorrow.

But today’s CAPE ratio is 182% of the median ratio of the past 137-years.

Given the mean-reverting nature of stock prices, the ratio is sending up storm warnings even if we cannot be sure exactly where and when the hurricane will come ashore.


This chart shows the Shiller Cyclically Adjusted PE Ratio (CAPE) from 1880-2017. Over this 137-year period, the mean ratio is 16.75, media ratio is 16.12, low is 4.78 (Dec 1920) and high is 44.19 (Dec 1999). Right now the 33.68 ratio is above the level of the Panic of 2008, and above the level of the market crash that started the Great Depression.

With the likelihood of a bubble clear, we can now turn to bubble dynamics. The analysis begins with the fact that there are two distinct types of bubbles.

Some bubbles are driven by narrative, and others by cheap credit.

Narrative bubbles and credit bubbles burst for different reasons at different times. The difference is critical in knowing what to look for when you time bubbles, and for understanding who gets hurt when they burst.

A narrative-driven bubble is based on a story, or new paradigm, that justifies abandoning traditional valuation metrics. The most famous case of a narrative bubble is the late 1960s, early 1970s “Nifty Fifty” list of fifty stocks that were considered high growth with nowhere to go but up.

The Nifty Fifty were often referred to as “one decision” stocks because you would just buy them and never sell. No further thought was required. Of course, the Nifty Fifty crashed with the overall market in 1974 and remained in an eight-year bear market until a new bull market began in 1982.

The dot.com bubble of the late 1990s is another famous example of a narrative bubble. Investors bid up stock prices without regard to earnings, PE ratios, profits, discounted cash flow or healthy balance sheets.

All that mattered were “eyeballs,” “clicks,” and other superficial internet metrics. The dot.com bubble crashed and burned in 2000. The NASDAQ fell from over 5,000 to around 2,000, then took sixteen years to regain that lost ground before recently making new highs.

Of course, many dot.com companies did not recover their bubble valuations because they went bankrupt, never to be heard from again.

The credit-driven bubble has a different dynamic than a narrative-bubble. If professional investors and brokers can borrow money at 3%, invest in stocks earning 5%, and leverage 3-to-1, they can earn 6% returns on equity plus healthy capital gains that can boost the total return to 10% or higher. Even greater returns are possible using off-balance sheet derivatives.

Credit bubbles don’t need a narrative or a good story. They just need easy money.

A narrative bubble bursts when the story changes. It’s exactly like The Emperor’s New Clothes where loyal subjects go along with the pretense that the emperor is finely dressed until a little boy shouts out that the emperor is actually naked.

Psychology and behavior change in an instant.

When investors realized in 2000 that Pets.com was not the next Amazon but just a sock-puppet mascot with negative cash flow, the stock crashed 98% in 9 months from IPO to bankruptcy. The sock-puppet had no clothes.

A credit bubble bursts when the credit dries up. The Fed won’t raise interest rates just to pop a bubble — they would rather clean up the mess afterwards that try to guess when a bubble exists in the first place.

But the Fed will raise rates for other reasons, including the illusory Phillips Curve that assumes a tradeoff between low unemployment and high inflation, currency wars, inflation or to move away from the zero bound before the next recession. It doesn’t matter.

Higher rates are a case of “taking away the punch bowl” and can cause a credit bubble to burst.

The other leading cause of bursting credit bubbles is rising credit losses. Higher credit losses can emerge in junk bonds (1989), emerging markets (1998), or commercial real estate (2008).

Credit crack-ups in one sector lead to tightening credit conditions in all sectors and lead in turn to recessions and stock market corrections.

What type of bubble are we in now? What signs should investors look for to gauge when this bubble will burst?

My starting hypothesis is that we are in a credit bubble, not a narrative bubble. There is no dominant story similar to the Nifty Fifty or dot.com days. Investors do look at traditional valuation metrics rather than invented substitutes contained in corporate press releases and Wall Street research. But even traditional valuation metrics can turn on a dime when the credit spigot is turned off.

Milton Friedman famously said the monetary policy acts with a lag. The Fed has force-fed the economy easy money with zero rates from 2008 to 2015 and abnormally low rates ever since. Now the effects have emerged.

On top of zero or low rates, the Fed printed almost $4 trillion of new money under its QE programs. Inflation has not appeared in consumer prices, but it has appeared in asset prices. Stocks, bonds, commodities and real estate are all levitating above an ocean of margin loans, student loans, auto loans, credit cards, mortgages, and their derivatives.

Now the Fed is throwing the gears in reverse. They are taking away the punchbowl.

The Fed is on course to raise interest rates again in March, under new chairman, Jerome Powell. In addition, the Fed is undertaking QE in reverse by reducing its balance sheet and contracting the base money supply. This is called quantitative tightening or QT.

Credit conditions are already starting to affect the real economy. Student loan losses are skyrocketing, which stands in the way of household formation and geographic mobility for recent graduates. Losses are also soaring on subprime auto loans, which has put a lid on new car sales. As these losses ripple through the economy, mortgages and credit cards will be the next to feel the pinch.

A recession will follow soon.

The stock market is going to correct in the face of rising credit losses and tightening credit conditions.

No one knows exactly when it’ll happen, but the time to prepare is now. Once the market corrects, it’ll be too late to act.


nope-1004 Lost in translation Wed, 01/17/2018 - 18:45 Permalink

I have yet to read or hear any analyst with a forecast mention the fact that the markets and dollar index are all one giant computer game, with entries changed / modified with a simple click of a mouse.

I don't think P/E ratios would ever matter to the unicorns in Never-Never-Land.  What's different about this economy?  Why should this fake economy correct but fairy tales never do?

Fake is fake.  What you expect SHOULD happen never does.

In reply to by Lost in translation

Mark777 truthseeker47 Thu, 01/18/2018 - 10:35 Permalink

Reality check:  There are many good reasons why the world economic system faces dire times.  They've been "kicking the can down the road" year after year, administration after administration.  Just because Jim Rickards, Jim Rogers, Mike Maloney, Harvey Dent and others have warned of that financial risk exposure doesn't make them wrong.

They felt that when the central banks bailed out big companies, rather than let them feel the pain and consequences of failure, then they were (1) kicking the can down the road and (2) making the next financial crisis even worse.  What seems to have happened is that the world's movers and shakers have done an end run around consequences - for now.

Why didn't the early Rickards predictions pan out?  Because #1 he didn't expect them to do wholesale currency printing.  Now it is acknowledged that virtually all central banks have done Quantitative Easing (QE)  That worked for a while but that delay only made the pending issues worse.

Well, #2 the central banks, or at least some of them, have kicked the can down the road yet again.  How?  They're now buying private equities, you know, stocks!  No wonder the stock market is melting up.  Even Glenn Beck in the past week noted that, he's expecting a Melt Up of the DOW to 30,000 even 40,000 or so.

Don't believe it?  Look into the SNB billions of profits recently announced.  It's not just the negative interest rates, they're also one of the giant entities buying up stocks.

For a long time I figured the stocks were going up because the currencies were losing value.  But it turns out us little guys are competing against the Big Players that have jumped in.

In reply to by truthseeker47

MK ULTRA Alpha NoDebt Wed, 01/17/2018 - 18:28 Permalink

A correction is needed to build a strong foundation. I doubt we'll see a correction in 2018 considering firms like Apple moving $350 billion to the US, with plans to buy back stock, pay dividends, invest in capital equipment and hire 20,000 new employees. Now multiply that by a factor of ten, 2018 will be a super boom year with over 4% GDP growth. 2018 wealth creation of over $800 billion.

And don't forget, US hydrocarbon production is breaking records each month. By the end of 2018, the US will challenge Russia as the largest producer of crude oil the world has ever seen. Trump policy isn't an independence from OPEC policy of the past, Trump ordered the US to DOMINATE the global energy sector.

Trump is God.

In reply to by NoDebt

MK ULTRA Alpha Selly2k Wed, 01/17/2018 - 19:13 Permalink

GDP growth of 4% in 2018 means a firm foundation for the equity markets. DOW 30,000 in 2018.

US crude oil production between 12 million to 14 million barrels per day over the next three years. Right now, pipelines companies are in the greatest boom in history.

Evidently, you use the television for your information gathering process, it requires one to read, and read, which you're unwilling to do. Because when I present documented economic facts, you use that television fantasy programmed mind control logic to ignore evidence of reality.

There are wave after wave of positive economic growth numbers and reports indicating a super boom is upon us, but you want to hide in your mind with your doom and gloom wants and needs because you've been brain washed by the hate America, the destroy America, communist indoctrination. You were conditioned like Pavloffs dog to ignore reality, to live in a reality created by the communist.

America is winning. And you don't like it, why?

In reply to by Selly2k

MK ULTRA Alpha debunker Wed, 01/17/2018 - 19:26 Permalink

I'm taking a long shot belief since I read about the multi-billion barrel find on the north slope of Alaska in spring 2017. There is real hard science using the latest technology, never before used, indicating huge hydrocarbon reservoirs. Just like Russia has huge deposits in northern Siberia, it's the same for northern Alaska and Canada. The problem isn't finding the oil, it's transporting the oil. 

Investment capital is pouring into the US at a rate never before seen in the history of the world. Investments across the board including a massive increases in the hydrocarbon sector.

The big oil companies are back and are pouring investment capital across the nation. It's huge.

By the end of 2018, the US which is breaking record after record, will outpace Russia as the largest producer of crude oil in the world. It only takes 11 million per day, which the US has broken it's own production record of over 10 million barrels per day.

And, most of the increases won't be fracking, but discovery, drilling and production of finds similar to the multi-billion barrel find in the Spring of 2017. It's huge, and again, the pipeline industry is in the economic boom of the ages.

Trump is God.

In reply to by debunker

francis scott … MK ULTRA Alpha Thu, 01/18/2018 - 04:08 Permalink

So Ultra Deluxe, not only did you drink the Cool Aid

but now you're selling it.  I've read a few full-of-shit 

comments here but yours takes the prize.


So the US will out-produce Russia by the end of 2018.

Could that be because the Russians have agreed to cut

their production until the end of the year. :-/


And you say:

      most of the increases won't be fracking, 


But the Financial Times says:


        The country’s oil companies have said they risk losing ground to the US shale industry,               which has been rejuvenated by the 30 per cent recovery in prices over the past 12 months.


I'd love to meet you for a latte one day but I'm afraid you'll explode and cover me

me with your shit. 



In reply to by MK ULTRA Alpha

rphb Wed, 01/17/2018 - 18:22 Permalink

The title of this article does not match its content.

What Rickard's actually says here is far less hyperbolic, then what the title suggest, making it just clickbait. I thought zerohedge was better then this.

Dr. Engali Wed, 01/17/2018 - 18:23 Permalink

Good Lord. These fools keep trying to apply fundamentals and technicals to a policy tool. One would think that after nine years they could have figured it out. That is of course your livelihood depends on selling a newsletter. 

MusicIsYou Wed, 01/17/2018 - 18:28 Permalink

The world's(especially the U.S) already broken with rampant corruption, and bankers along with corporations that just print themselves piles and piles of money.

MusicIsYou Wed, 01/17/2018 - 18:29 Permalink

The world's(especially the U.S) already broken with rampant corruption, and bankers along with corporations that just print themselves piles and piles of money.

MusicIsYou Wed, 01/17/2018 - 18:32 Permalink

Hey guess what central bankers? If you don't pop all the asset bubbles you can take it to the bank that God is gonna crash a big fcking asteroid ontop of Washington D.C


Clock Crasher Wed, 01/17/2018 - 18:34 Permalink

This ends in disaster.  When?  All depends on the degree to which the public is aware and informed.  Likely sometime just before the next ice age.  

Metals need to base for another year, at least.  

Clock Crasher Wed, 01/17/2018 - 18:38 Permalink

When the Obama packed his administration with wall to wall fiat-jihadi-insurgents they immediately exonerated themselves for the financial destruction of America and self designated themselves untouchable.  

The rest is history.  Everyone knows America is full blown lawless.  The only thing that can bring down the stock market is a return of the justice departments.  

Chances of that happening are 0.00000000000001%

If you want to see what the future vix charts are going to look like look at short term interest rates.  Observe a decline to zero followed by no movement for a decade(s). 

shimmy Wed, 01/17/2018 - 18:40 Permalink

People like this remind me of the climate change doom and gloomers who continually talk about how the end is near and all this other fear mongering shit and are continually shown to be wrong.