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Article posted by student A:
Is The Stock Market About To Crash?
I saw this article today on CNBC entitled “David Stockman: Stocks will plunge 50% in this 'daredevil market'”.
The article is written by Stephanie Landsman but she is mostly reporting on what David Stockman has forecasted. He is predicting a dramatic drop to the whole stock market primarily because the stock market has seen “about eight or nine years” of expansion and that the last two stock market downturns were about 7 or 8 years apart. He also notes that the Trump tax cuts are, for the most part, not having a noticeably large positive impact on the economy, but that the market is still pricing in a large positive impact. David Stockman is also fearful that a “black swan” (some unpredictable event) will result in this dramatic stock market drop. He does state that he believes that we could see the EPS for the S&P 500 drop to $75 from where it is currently, around $192. This would definitely affect the fundamental value of the S&P 500 stocks but he doesn’t specifically say why earnings in this country will drop so dramatically (other than he thinks we are due for a recession) and why he specifically predicts $75 per share (maybe because that was a low in 2010).
David Stockman’s prediction about a stock market plunge seems to be largely based on a gut feeling rather than a numerical analysis of the market. The risks he brings up are real but I don’t think it logically follows to say that the stock market must crash anytime soon if it has had a long run of growth (especially if that growth is supported by fundamental value). I found this document with a chart comparing earnings growth and price growth for the S&P 500 from May 2008 until about a month ago. It appears to me that the S&P might be a little overpriced right now but in general, it seems like the price is tracking with earnings. It is inevitable that we will encounter another recession in this country but I have not seen any compelling evidence that our next recession is on the near-term horizon, in fact it seems like we are still in the natural upswing following the “Great Recession” that started in 2008 (more on accelerating earnings growth can be found in the same document I linked to above). Gut feelings about the future are not without value but they are accompanied by the potential pitfall of overreacting or underreacting significantly to information based on your emotions at the moment. Basing your predictions about the future on concrete facts paired with accurate, realistic, and reasonable models is, in my estimation, a much surer path to correct predictions.
I also want to say that our current period of growth in the stock market may be unprecedented in recent history but that does not mean it will not continue for the foreseeable future. The fact that in 2008 we began the most dramatic economic downturn seen in this country in almost 80 years (i.e. “unprecedented in recent history”) to me means that it is less likely that we can rely on patterns seen in “normal” times to hold true for events related to that downturn, like the recovery period that is following it.
Here is reply：
David,
I think you’ve selected a great article to review. I think this article is a wonderful representation of the hyperbole in the financial press, and I believe David Stockman is an interesting case study in how well hyperbole sells. His implied changes in earnings seem to be rounded to an even number to make it easier to digest and feels pretty baseless as you’ve pointed out.
First, lets review his implied changes in earnings and valuation. His assertion is that EPS will drop to $75 per share, and his price target based on this is $1,600.001. Utilizing the same risk premium and risk-free rate sources from lecture, and updated S&P 500 price targets as of June 8th, 2018, the current implied growth rate of the S&P 500 is 2.35%, well below the average annual growth rate and very near the current estimate of GDP for the most recent quarter annualized of 2.2%2. Reverse engineering David Stockman’s estimates yields an implied growth rate of 1.43%, well below GDP and current inflation rate. Appendix A contains calculations. This argument ignores several benchmarks for growth and relies on a fundamentally shallow metric of EPS. EPS estimates are far too shallow to account for changes in accounting or deferral of revenues and he is likely missing broader investments companies may be making in future growth. His entire argument may simply be countered by future revenue growth from investments made now. Lastly, he appears to back down from his own argument when pressed for a time frame. The only statement he makes is essentially that a black swan event is coming some time1. It is certainly fair to say that some time in the future stocks will lose value due to natural business cycles, however by leaving the door open on time frame he has conceded he isn’t sure when all of this could happen.
Considering the fact that the argument is relatively baseless, I believe reviewing David Stockman’s credentials reveals the real reason for making such strong statements. The interviewee on CNBC actually has his own blog and set of books sounding the alarm for an inevitable plunge in the market3. Contained on the website are a lot of other pretty far-out-there assertions about a wide variety of topics. I believe the purpose of espousing such hyperbole is likely to generate interest in the author and encourage readers to seek out more information on David Stockman. If I had to sell books and blogs for a living, I would likely attempt to generate traffic to my site by any way possible- and I believe interviews like these are a way to accomplish that. David Stockman has appeared several other times on CNBC making the same claims, a quick Google search shows as far back as early 2015 he was claiming to get out of stocks because of impending doom4. The combination of the actual data and his suspect motivations appear to confirm a stock market plunge is not happening now for the reasons he suggests.
1. Landsman, S. (2018, June 06). David Stockman: Stocks will plunge 50% in this 'daredevil market'. Retrieved from https://www.cnbc.com/2018/06/06/david-stockman-predicts-50-percent-stock-market-plunge.html
2. US Department of Commerce, BEA, & Bureau of Economic Analysis. (n.d.). Bureau of Economic Analysis. Retrieved from https://www.bea.gov/newsreleases/glance.htm
3. David Stockman. (2018, June 10). Retrieved from http://davidstockmanscontracorner.com/author/stockdav/
4. Google Search: David Stockman CNBC. (2018, June 10). Retrieved from https://www.google.com/search?q=david stockman cnbc&oq=david stockman cnbc&aqs=chrome.0.0j69i60l3j0l2.4838j0j4&sourceid=chrome&ie=UTF-8
Appendix a.
|
|
Current |
Estimated |
|
Index Level |
$2,779 |
$1,600 |
|
Book Value |
$826.50 |
$826.50 |
|
P/B |
3.362 |
1.936 |
|
Book to Price Ratio |
0.297 |
0.517 |
|
Forward Earnings |
$166 |
$75 |
|
Long Term Treasury Yield |
3.06% |
3.06% |
|
Risk Premium |
4.85% |
4.85% |
|
Forward ROCE |
20.1% |
9.1% |
|
Required Return |
7.91% |
7.91% |
|
g |
2.354% |
1.435% |
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