When something is a bubble, most market participants cannot see it because they are part of it, moving with it. In fact, history shows that they think it will continue forever, that trees will grow to reach the sky, etc. Why do they think this? Simply because it seems to have been working like that for a long time and thus the locality of reference doctrine (a computer engineering term which I am for the first time hijacking for application as a parallel reference to herding behavior) suggests to the herd that it will keep on happening. You look to the left and they are still running. You look to the right and, yep, they are still running as well. Guess I'll keep running too. When something bad happens, we'll deal with it then (read the lyrics of Adele's "Skyfall"...) but for now the spiked punch bowl is open and the sky is the limit. A more common way of saying "locality of reference" is "the trend is your friend". Trend following is clearly herding behavior. Trend followers don't care about fundamentals, they simply care about what everyone else is doing.
At the other extreme we have those who sit apart from the herd: watcher-theorists if you will. You can always spot these people because they look at logic and data more than anything else. Mish is a watcher-theorist. Alan Greenspan is as well. All the famous Austrian economists like Rothbard are/were watcher-theorists. They all know when something is unsustainable when they review the data. Remember Greenspan's warning about irrational exuberance? He was correct but significantly early that if you just listened to his warning you would have been on the sidelines for even more gains (and then perhaps jumped back in right as the collapse was about to begin).
Elliotticians are part of a 3rd class: watcher-chartists. We also know when something is unsustainable but we do not discount the fact that irrational behavior can continue longer than anyone ever expects. Stampedes are difficult to predict without some kind of model. For example, this recent article by well followed and highly regarded Seeking Alpha contributor Eric Parnell is not his first regarding the overvaluation of stocks. Many people have been calling this a bubble market for a long time. But this time he is lucky to be getting a clear blow off top in investor sentiment (see chart below) which allows him to pretty safely entitle the article to "The Greatest Fool is Here". His view that (paraphrased) "when everyone is 100% confident there are no buyers left" is correct. These markets are zero sum games where losers pay (or default on) winners; wealth is only transferred, never created by markets. These are clear watcher-theorist kinds of statements. But high sentiment can linger for quite some time before it reverses so a high instantaneous sentiment reading is not a clear market sell indicator.
So is some kind of major correction neigh? IMO as a watcher-chartist, yes, the chart setup is there on MANY fronts that supports the possibility of a major collapse but as of yet there is no chart confirmation. On the Economati Subscribers site I have posted models for many stocks and indices (like banking/BKX) whose Elliott wave counts strongly suggest a major peak is near. Since the models themselves will indicate when they are likely playing out as expected in addition to when the model itself has failed we can time the markets using them as long as we use stop losses so that near term head fakes do not kill us off.
My latest warning chart is that of ITB, the Ishares US Home Construction ETF. Alan Greenspan once said something I have never forgotten which is that housing essentially is the US economy. At the time I recall most people not really understanding what he was saying. After all, the housing industry is but a small fraction of the US GDP. However, since I view everything every economic head says through the lens of a debt Ponzi Scheme and since Greenspan has clearly shown past understanding of the big picture scam of fake money, I knew that what Greenspan was really referring to was not GDP but rather the entire concept of the current American economy. That's because our economy is based on fractional reserve lending. That is a Ponzi scheme, period.
I'm neither the first nor the only one to believe this. I like this article from 2010 which has Mike Shedlock quoted as, "I have always thought 10% reserves were too risky, but in 1994, bankers convinced Alan Greenspan to introduce “sweeps” so that they could push the 10% reserve requirement envelope even further to see just how shaky our Ponzi banking system could become." It also quotes Rothbard as saying, "It should be clear that modern fractional reserve banking is a shell game, a Ponzi scheme, a fraud in which fake warehouse receipts are issued and circulate as equivalent to the cash supposedly represented by the receipts”.
The fact that fractional reserve banking is clearly a Ponzi scheme is bad enough. But its fraudulent nature is compounded because it is based on a fraudulent monetary base. That's Ponzi ^^2; a con based on a con. It simply means that there will be a cascading collapse at some point. First the people will lose confidence in fractional reserve lending and then in the money supply itself. In my mind, what is most likely to cause this is what I have been calling the Supernova effect for a long time. First you have the deflationary credit collapse that bankrupts the banking system and then you have government go into high gear with money printing and other accommodations trying to reverse it. Sooner or later the government actions undermine confidence in the issuing authority and when that goes, the con game is over in the form of hyperinflation.
So why is housing so critically important? Simply because it is the largest asset on the balance sheets of banks, by far. The fake, Ponzified valuation of housing thus represents fake "capital" which banks can use as reserves in offering further credit. The more credit they offer, the easier terms it has to be offered at in order to get anyone to take it (laws of supply and demand govern the credit industry folks...). The easier it is to obtain credit, the more debt people are able to take on to buy housing, thus pushing housing prices up in a self reinforcing spiral. This can never happen without a money supply that allows creation of new spending power from thin air simply by asking for it from a bank.
But trees don't grow to reach the sky and no it won't be different this time. When housing valuations stop going up then the banks become unable to loan more under the rules and if housing valuations go down and stay down then banks become "capital impaired" which is a nice way of saying bankrupt under the rules. Credit becomes very tight as evidenced by rising interest rates. Yes, they respond to supply and demand as well! When the hugely ponzified national banks can no longer offer loans, the more conservative ones (like local banks and credit unions) will have less competition for loans and so interest rates rise. It feeds on itself on the way down just like it did on the way up.
Of course the rules can be set aside temporarily without causing the participants to panic but if the rules are set aside permanently then history shows time and again that confidence will be lost in the issuing authority and the people will simply stop using the fake money; the demand for it will collapse and thus its value will collapse (again, supply and demand 101). Most people do not understand that this collapse in confidence, once begun, is beyond the control of the government to stop. We have a faith based, un-backed money supply which, being inherently worthless, will eventually become practically/economically worthless when the people lose confidence in it.
In other words, it's a straight up con game.
Keep an eye on housing markets and interest rates and you will know where things are heading.
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