What will trigger the next market crash?


Monday, October 09, 2017 // Written by Enzio von Pfeil
We read the Financial Times and Economist regularly as part of our intellectual diet.  Both carried articles this week about the non-likelihood of a market crash. We differ: "black swans" have been circling for some time already...


1.  1.  Recent history. “Stock markets are on a vintage tear. Entering yesterday (6th October 2017), and with the tenth anniversary of the S&P’s pre-crisis peak to come on Monday (9th October 2017), the main US index set its sixth successive all-time high. The last time it enjoyed such a streak was two decades ago.” [1]

 

2.  What causes crashes?  There are three classical triggers:

a.  The cyclical one occurs when markets reach cyclical peaks and then crash;  

b.  The valuation  one occurs when markets reach valuation highs and then crash, and

c.   The random one occurs “out-of-the-blue” – one justified by us soporific  analysts with 20/20 hindsight.

 

3.  Testing the above, our view is simple: the only “fly in the ointment” is a random event.

a.  Cyclical. The Economic Clock® is ticking along nicely. Currently, the global economy is enjoying that golden Economic Time® characterised by an

                                         i.    excess supply of money – aka global quantitative easing -  and

                                       ii.    an excess demand for goods, aka synchronised growth of economies as well as robust corporate profits.

                                      iii.    This golden Economic Time® is set to continue[2] on account of structural factors which you all know about:

                                     iv.    Globalisation has weakened the power of unions to spark wage-push “Phillips-curve-style” inflation cycles;

                                       v.    Technology has had the same effect, recuding unit labour costs, and

                                     vi.    Demography   No prizes for guessing that esp. we of the G-3 are ageing, not to mention those sun-seekers in China and Russia. 

1.  Financial avarice. Indeed, one major cause of today’s financial avarice is, which went out the window decades ago. This single event led credence to what is on America’s money: “In God we trust” – implying that  cash is better.  The removal of defined-benefit pensions along with all-time low interest rates mean that people have to save more and more just to keep up. What a “wheelchair” race!

b.  Valuation. High valuations never “cause” crashes; instead, they are used in 20-20 hindsight by disingenuous analysts when justifying why they screwed-up in the first place by not anticipating a crash. As some solace, however, to those believing that high valuations do cause crashes: turn to chart four of this week’s “The bull market in everything” Economist, p. 21: America’s cyclically-adjusted PE ratio, or CAPE, is 1/3 below its all-time peak back in early 2000. 

c.   Random. Here is the snag.  In blogs past, I have suggested that unforeseen brush fires in the following well could lead to another 2007/8 financial crisis:

                                         i.    Automobile-backed securities

                                       ii.    Mortgage backed securities, and

                                      iii.    Student-loan backed securities.

 

You all know about these three areas, so it is tedious to recapitulate your knowledge.

 

4.  Action plan. Instead of us trying to predict when one of these three black swans will hit the windshield, just keep an eye on these yourselves when reading research.  Please send us some smoke signals in case you run across any interesting insights re. which random event might trigger our next market crash.

 

 



[1] Authers, John: pressure on fees is spreading the gains from this bull run, in: Financial Times, 7th-8th October 2017. P. 18

[2] Yes, we all know that quantitative tightening is on the way, but I, for one, don’t think that it will make much of a dent in that excess supply of money sloshing about, ”excess” to sluggish global growth prospects. It cannot be in central banks’ interest to hike rates to such a degree that crashes occur. After all, it is the central banks that will be cutting themselves in the foot – and having to bail the victims out yet again…


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