Stock Market Crash! - Possible S&P 500 target?

Hi Guys,

Long time member, now infrequent poster.

I was wondering if anyone here had a view on the S&P 500 and possible downside targets.

Logic for my short position: The problems with the financial system were never fixed, debt is as high as ever or higher, fundamentals look no better, PE ratios in the housing market are high, and general bad sentiment seems to be seeping into the mainstream media. The central bank is in a worse position to react now because interest rates are lower than they were in 2008/9 and QE less likely.

My thoughts on a target: The lows of early 2009. So about 800. Nothing has changed, everything is worse than it was back then.

So, change my mind, Tell me where I'm wrong, offer your thoughts on the target.

Very interested to hear responses!

Leon

Hi Leon,
In a previous life I was an institutional fund manager in the US equity market.

The investment theory holds that the value of a security - and by simple extension, the entire market - is the discounted value of all the expected net cash flows the assets owned by the security/market are going to generate. Simplify this down and just say the market is valued on future expected profits & future expected interest rate levels.

So, whether conditions are good or bad now is not the main point - that news is already in the price. What counts is whether corporate profits will be better or worse than is currently consensus expected; and whether interest rates will be higher or lower than current consensus estimates. Higher profits are obviously good, as are lower interest rates, and vice-versa.

I don't follow the US market closely any more so I've no idea what the answer to those two questions might be. Your view is as valid as everyone else's but the market could happily go either way, or stay where it is, depending on how the future in these two respects pans out in reality relative to current consensus expectations of that future. All the factors you mention are valid influences on profits and interest rates but what really matters is whether your view on these things is more bearish or bullish than the current consensus for them, and then, of course, whether the future proves you right or wrong!

My prior experience tells me not to predict. I am willing to believe just about anything can happen and no-one has a reliable crystal ball to gaze into. So I prefer to react than predict - it's why I became a price action trader, much easier that way! If you are bearish then you should go short with the courage of your convictions, just have a plan in place in case you are wrong. Good luck!

Thanks for your thoughtful response

I was hoping to encourage some people to offer counter arguments so I could consider them and test my bias. Your point about all available information being discounted into the price did this, and I'd respond:

(a) Doesn't fear play a part? Is all information relating to the price REALLY discounted? Or can we predict future prices based on current prices and sentiment? Surely you need to accept this axiom to trade price action as you do?

(b) How about the long and short term debt cycles? Asset prices rising with expansion of the money supply, and dropping with it's contraction? Surely this information can't be discounted, as it's ongoing as time passes.

Your argument reminds me of EMH, but again, you can't believe in that if you're a trader, can you?

Thanks for the response again (Y) Where in the UK are you btw?

Leon

EDIT: I'm not sure if my post is a good response. In a way I seem like I'm talking past you, but in another I feel like I'm hitting on an actual disagreement. You're arguing that everything is priced into the market, but how can that be true if you're trading and hoping to profit? If we consider news on IRs or company profits, prior to the news release they are not priced into the marker, but afterword they are - how much later than their becoming public are they priced into the market? This is the crux maybe. We don't know when anything is priced/discounted, maybe it is within a minute, or a day later, and maybe people are reevaluating their decisions constantly, thus making the idea of the "real value" meaningless.

All this being said, I definitely take and accept your point that profits and IRs are amongst the main drivers. Of course it would do me well to keep this in mind.

Hi Leon,
To try to address your points, in order:

1) Yes, fear - and, of course, greed - are huge components of what drives human investment decisions. The investment theory (indeed, most of economic theory in general) suffers from the assumption that people act rationally and we know that simply isn't true; hence the rise of the whole branch of behavioural economics to tackle this flaw.

2) All publicly known price sensitive information + consensus future expectations are deemed to be pretty efficiently discounted in current prices. I don't think that's so wildly wrong. You can't, however, predict future sentiment, that can be anything at any time for any reason - and then we are back to fear & greed having a direct impact on prices, and this is an unknown until it happens. So you have to react as you can't predict and we are back to my trading stance!

3) You also, by defintion, cannot have 'black swan' type events discounted in prices. Any surprise - say an unexpected corporate profit warning - means prices have to make an immediate adjustment. Prices want to be at an equilibrium position for all available information and, once there they fluctuate largely because of minor sentiment changes (ranging markets). If this equilibirum is disturbed by out-of-consensus news it moves in volatile way until a new equilibrium is reached (trending markets). Major sentiment changes would have a similar disequilibrium effect.

4) All of this means price fluctuation in markets is inherent and natural. That's all I need to trade, I don't need to know why they change, just to observe how they do so. Price action trading is kind of an ultimate dumbing down, if you like, observation & reaction, not understanding & prediction. I do the former, you are trying the latter. My opinion (having tried both) is that mine is easier!

5) Both the current position and the likely future development of debt cycles, money supply, anything in fact, is consensus discounted as per the above argument. What can also change quite unpredictably is the sentiment to how this is perceived. So, sometimes we have a debt crisis which is about to overwhelm us, sometimes it's not a big problem. The debt hasn't changed, it's the sentiment that has. Go figure. I don't try to any more.

6) I'm OK with the principle of EMH subject to the limitations discussed above. The above argument also explains why it doesn't mean I can't be a price action trader perfectly happliy, even in a (near) efficient world.

7) A final point on price adjustment to news and/or changing sentiment is that investment theory again erroneously implicitly assumes people adjust instantly, and again this is clearly not true. People adjust at different speeds and to differing degrees depending on their interpretation of the event, which is why trends tend to persist. More fuel for the trader to exploit!

NB I see you are up north, I am in the sunny south, in London (though today, the weather reminds me of Manchester!)

Why did this happen, why it crashed? Is there any rumors in the market..?