Euphoria is one of the best predictors of a stock market crash. And, as it stands, we are seeing a significant amount of it. Stock investors, be careful; we could be setting up for massive stock market losses ahead.
What is stock euphoria? It’s when most investors, without paying attention to the fundamentals, buy stocks with the expectation of even better returns going forward. That’s exactly what is going on today.
Let me provide some evidence…
Just recently, Charles Schwab Corp (NYSE:SCHW), one of the biggest and best-known brokerage houses in the United States, reported its financial results for the second quarter of 2017. It said that in the second quarter, the firm opened 350,000 new brokerage accounts. It also said that, for the first half of the year, new accounts amounted to 719,000. This was its highest number of new accounts opened in the first half of a year in 17 years! (Source: “Schwab Reports Record Quarterly Net Income Of $575 Million, Up 27%,” Charles Schwab Corporation, July 18, 2017.)
There are severe net inflows of capital into long-term stock mutual funds and exchange-traded funds (ETFs). In the first five months of 2017, inflows to these stock funds amounted to $108.8 billion, compared to outflows of $50.5 billion in the same period of 2016. (Source: “Summary: Combined Estimated Long-Term Flows and ETF Net Issuance Data (xls),” Investment Company Institute, last accessed August 1, 2017.)
How significant is this? Stock markets are open for six-and-a-half hours a day, 20 days a month, which adds up to 130 hours per month. In the first five months of this year (650 hours), each hour the market was open, $167.4 million went into stock mutual funds and ETFs.
If this isn’t enough to make the case that stock market euphoria is here, look at the chart below.
Chart courtesy of StockCharts.com
The chart above shows the American Association of Individual Investors (AAII) bear index. Essentially, it’s the percentage of average investors who are bearish. Since March, the number of bearish stock investors has declined substantially.
Dear reader; the mainstream media will report daily the new highs that the stock market is making, but you’ll hardly ever see them warning of a stock market crash.
What’s happening in the markets these days isn’t normal. There’s too much irrationality; basic fundamentals are tormented. Valuations are extremely expensive, economic growth isn’t there, there’s political uncertainty, the global economy is struggling, and the list goes on.
From history, we know that irrationality and euphoria can go on for a while, but eventually investors do come to their senses. And when they do, there is always a stock market crash. We have seen this over and over again. This time, it’s no different.
Please remember, the higher that key stock indices go, the bigger the stock market crash is going to be. Capital preservation isn’t a bad idea in times when most investors are rushing to buy stocks.