This is What it Looks Like Right Before a Crash

Right now, I am seeing more fear of an impending market crash, an impending recession, or even depression than I've seen in a long time. Those fears seem justified considering it looks like the S&P 500 has put in a top, U.S. unemployment rate is rising, and the effects of the U.S. war with Iran rippling through the economy. But unfortunately, we don't have to sit in fear. We Knowing what these four things are means you can look around and see, are they happening right now? These four things are number one, euphoria and FOMA. Number two, insane valuations. Number three, changes in monetary policy going from easy to tight. And then number four, the Uber driver or the dentist test, you've got idiots getting rich. So number one, we have to look at euphoria and fear of missing out. There's an old saying that markets climb a wall of worry. And that's because as long as there are risks in the market, those future risks are being priced into the present. So when there are things to panic about, there are things to be fearful of. That is traditionally something you want to see in the market because it means they're still upside if those risks don't pan out. On the flip side, when there is euphoria, when it looks like there's only a golden streamlined path ahead to wealth and riches, and everybody thinks, man, this is easy. Markets have entered a new age or a new permanent plateau. Those are the times when all of the potential good things in the future have already been priced into the present and none of the risks are being priced in. Now it's easy to spot things like euphoria and FOMO in retrospect. So we'll highlight a couple of examples before the great financial crisis. There was euphoria and FOMO with buying homes. Many people bought one, two, three, four houses and they were just saying, yep, I'm going to get rich from this. Yeah, it doesn't matter if it's not rented out. I can always refinance later. And we all know how that story went. Before that it was a dot-com bubble. After that, we had a couple of euphoric bubbles and things like crypto. And then obviously in 2020 and 2021, we had euphoria across basically every single asset class with real estate, stocks, crypto, gold, everything skyrocketing. That's when you have 19 and 20 year olds starting TikTok channels of day trading and getting rich. And everybody is piling into every speculative asset they can possibly think of because they don't want to be the sucker that loses out on getting rich when all the idiots are. Now, as of the time of this recording, one of the measures of euphoria or greed in the market is near an all-time low. The fear-greed index from CNN, as of the time of this recording, is at 17. That is well within extreme fear territory. And part of that fear is obviously justified. As of the time of this recording, the market is now in correction territory down 5% from its high. Also worth noting, it has just broken below its 200-day moving average. Now, for those of you who don't know the data, it's basically a 50-50 split. If you look at every single time the S&P 500 breaks through its 200-day moving average, the market is up six months later about half the time and the market is down six months later about half the time. Kind of a coin flip, not really a big signal here, but it's worth noting because people pay attention to it and it causes fear. The way that this fear and greed index is measured is by looking at things like market momentum, which is in extreme fear. Stock price strength, which is net new 52-week highs and lows on the New York Stock Exchange, which is in extreme fear right now. Stock market breadth, which is in extreme fear. Put and call option ratio, which is in extreme fear. Most people are interested in buying puts over calls right now for protection. And then market volatility is neutral right now. The VIX did spike recently, but it's settled out a little bit. Safe haven demand is also in extreme fear, which is the difference in 20-day stock and bond returns. Junk bond demand, which is the yield spread between junk bonds and investment grade bonds, is also in extreme fear territory. The most bullish or greedy or euphoric reading we have here in this indicator is with the VIX, which is at neutral. Every other part of this indicator is in extreme fear territory. I don't know if you pay attention to the live streams that I've been doing on YouTube lately, but I've been getting a lot of comments on those live streams about why the economy is crashing, why it feels like the market's going to turn over, what you can do to protect yourself on the way down, how to profit from the inevitable collapse and crash, and many statements of outright fear. There is very little euphoria anywhere in the market right now. And so indicator number one of a coming recession, depression, market crash, we don't have. Number two, we have insane valuations. Now it is true that if you look hard enough, you can always find stocks or assets that are valued way higher than you think that they should be. The question is, is this a widespread phenomenon or is it concentrated in a specific asset class or sector? For example, if you look at the largest stock in the stock market right now, which is Nvidia, it has a price to earnings ratio of only 36. And in fact, when you look at the forward P-E ratio compared to the trailing 12 month sales growth of many companies, they're actually in extremely attractive territories right now. To see a company that is valued very attractively, you want to see it as low on this chart as possible and as far to the right on this chart as possible. Companies that are high on this chart and to the left are extremely overvalued. In other words, the valuation that the market is assigning to these companies is extremely pricey compared to their proven track record of being able to make money. And you can see that there are not really that many companies that are outliers in being overvalued right now, but there are a lot of companies that look very attractively valued right now. But there is one area that is fairly overvalued right now, not a good sign for the sector, and that is actually consumer staples. Now, many people rush into consumer staples as a defensive sector. They want to put their money somewhere safe when everything looks like it's headed over a cliff. So when this area gets expensive, it's a warning sign that the masses might be wrong. And that's because if tech stocks, for example, have high valuations, for the most part, it's because investors are pricing in the chances that those tech companies are going to have really insane growth in the future. And so many times, tech stocks are justified in higher valuations like that. But consumer staples rarely, if ever, have that massive growth ahead of them. And even if they do, you're going to be looking at individual stocks, not the sector as a whole. And valuing consumer staples by Ford PE, if you take a look at where they are, they're the most expensive they've been since before the dotcom bubble. And last time they got this expensive from a valuation perspective, they fell by about 40 percent from top to bottom. And the S&P 500 beat them for about two years straight. So expensive consumer staples is a sign that the market has basically priced in the worst for the economy already means there's very little profit to be made there, especially when you compare it to tech stocks, which now have about the exact same valuation as consumer staples, which means that the area that the market is most concerned about right now, which is technology, might actually be undervalued already. The third thing you tend to see before crashes or recessions is changes in monetary policy going from easy to tight. One way that monetary policy shifts from easy to tight is their balance sheet. When the balance sheet is declining, that is a tightening period. When the balance sheet is rising, that is an easing period. One thing you'll notice is that since May of twenty twenty two, the Fed's balance sheet has been declining. So for like three years straight, we were in a tightening environment where the monetary policy was restricted. But zooming in on recent history, you can see the Fed is actually expanding their balance sheet yet again. She is going up. That's easing. So recently, like right now, the transition is not from easy to tight. It's from tight to easy. Now that is just the Fed's balance sheet. The other part of monetary policy is interest rates. This is the long term chart of the federal funds rate. And you can see that again from twenty twenty two through twenty twenty three, the Fed was raising interest rates and then they kept them steady up until September of twenty twenty four. That was a tightening environment. But since twenty twenty four, the Fed has been lowering interest rates and recently they voted to keep them steady. But assuming the data pans out the way they are hoping, they will continue to lower rates. So from every monetary policy action possible, we are not moving from an easy environment into a tighter environment. We're doing the opposite. The reason this matters is because that's what contributes to crashes. When the Federal Reserve last time moved from tight to easy, the stock market rose from bottom to top about one hundred twenty percent. And then when they moved from an easy environment to a tight environment, the stock market crashed about twenty seven percent from top to bottom. And you can also watch the effects of monetary policy to determine whether the cumulative effects are easy or tight by just looking at the money supply. And you can see over the last couple of years, the money supply is moving higher and it has no signs of turning around. In fact, coming bank deregulation soon, which I recently made a YouTube video about, we can expect that things will get easier because bank lending will be expanded. This will contribute to an easier environment. And then number four, the last sign that you tend to see right before a big market crash is idiots getting rich. Now, I call this the Uber driver test. It's also been called the dentist test. It's when people who have really no experience or business trading or investing start getting rich by trading or investing in an asset class and they start telling everybody about it. Your Uber driver tells you, hey, you should invest in invest in this crypto coin or this NFT or this company, this this penny stock. I'm getting rich from it. Your dentist starts telling you that they're investing in something. Now, for most of us, this is going to probably be a family member. All of us probably have a family member that asked us about buying Bitcoin right at the top, asked us how to sell their Bitcoin right at the bottom, asked us how to sell their gold at the bottom, buy gold at the top. They started day trading right at the end of twenty, twenty one or beginning of twenty, twenty two. And it's because by the time something gets to the point where so many people are making money on it, that the word travels to the people who are really just the edge of the market speculators. Most of the profits have already happened and they've already taken place. And these people usually end up being the bag holders. Now, this is slightly anecdotal. But if you think back about those people who you've had these encounters with in the past, I would be willing to bet that for most of us, those people have been pretty silent recently. There are no tick tock day traders right now. There's no Uber drivers getting rich. In fact, a lot of Uber drivers are scared of losing their jobs right now to automated cars like Waymo's and Tesla's. And so from every measure that usually happens before a big crash, whether it's euphoria, valuations, monetary policy or the Uber driver test, we're seeing very, very little of this anywhere. Now, that doesn't mean the cannot crash. Obviously, these things were true recently and the market is already down 5% from its high. Market could easily go down to be 10% from its high, 20% from its high or even more. So you should always manage risk as your number one priority. Never risk losing a large amount of money because losses are way more powerful than gains. If you have a 20% loss, you need a 25% gain just to get back to where you were. But if you have a 50% loss, now you need a 100% gain to get back to where you were. That's why the best investors and traders throughout history always eventually have learned the number one rule is to not lose money. Manage risk, cut your losses, don't lose money. If you can do that, then your profits will probably take care of themselves. But once you've learned how to manage risk, the second thing that you probably have to learn how to do is investing when things look like risks, because once they look like an opportunity, the profit has already happened. And the cool part is once you do learn how to manage risk, it gives you the ability to take more opportunities. It doesn't mean you're taking less as always. Thank you so much for watching. Have a great day.