STAFF NEWS & ANALYSIS
Market Crash? The Moon Is Blue and Reuters Makes a Reasonable Prediction
By Staff News & Analysis - August 25, 2014

Here's what it will take to trigger the next stock market correction … As Wall Street hit another new record Thursday, it is worth considering what could cause a serious setback in stock market prices around the world. Since I started writing this column in 2012, I have repeatedly argued that the rebound in stock market prices from their nadir in the 2008-09 global financial crisis was turning into a structural bull market that could continue into the next decade. Asset prices, however, never move in a straight line. It has been more than two years without even a 10 percent correction and five years without a 20 percent setback. This cannot go on. – Reuters

Dominant Social Theme: The stock market is doing just fine but needs a correction.

Free-Market Analysis: The moon is blue and we agree with Reuters. Yes, this is an unusual occurrence, especially with this particular columnist. But we do agree with his summation: Equity markets – especially the US market – are due for a correction, but not one that will necessarily ruin the Wall Street Party.

The difference between our view and this columnist is that we do not believe the stock market can be analyzed rationally – that it is at this point extremely artificial and more responsive to regulatory influences and monetary policy than any underlying "valuations."

The Wall Street Party is a thoroughly manufactured occurrence that has little relation to reality. But it exists. And it may well expand.

That won't do for the mainstream press, though. They can't mention the underlying artificiality. They're stuck with analyzing the markets through the prism of 20th century "value" disciplines, or perhaps modern portfolio theory. Either way, the idea is that markets are legitimate and providing fair pricing for equities.

Here's more:

Sometime in the not-too-distant future, investors are certain to suffer some big and painful losses — even if I am right in expecting equity prices to continue rising in the long term. What kind of event is most likely to end this bull run, or at least interrupt it with a setback of 20 percent or more? The obvious answer is a major economic crisis, such as the near-breakup of the eurozone in 2011-12 or a U.S. recession.

Another possible trigger would be a substantial increase in interest rates. All the worst bear markets in living memory — 1973-74, 1980-82, 2000-02 and 2007-09 — occurred after a series of rate hikes by the Federal Reserve, and monetary tightening is the most widely discussed investment risk today. But on closer inspection, neither economic fundamentals nor monetary policy looks like a serious threat, at least in the year ahead.

Almost all recent evidence from the U.S. economy suggests acceleration rather than slowdown. Though a renewed recession in Europe or Japan is more likely, this would not cause much financial shock, since neither of these economies has yet fully emerged from the slump of 2009.

An increase in interest rates big enough to trigger a stock market correction appears even less likely in the next 12 months. This is because stock markets tend not to react adversely to the start of a monetary tightening cycle, which generally signals an improving economic outlook.

History suggests that it takes a long series of rate hikes, spread over several years, to trigger a bear market. But if no major economic crisis or substantial monetary tightening is on the horizon in the next year or so, we must conclude either that equity prices will keep rising without interruption or that the next bear market will be caused by something other than monetary policy or economic fundamentals.

Well done, Reuters … at least on the surface. This is indeed a description of the risks the US market is facing given the central banking parameters that have already been set for it.

If the markets manage to negotiate the fall without tumbling off the proverbial cliff, we could see continued gains next year. Market crashes usually happen in autumn. Also, much of the current negative conversation taking place revolves around market overvaluations and fragility.

The article, in fact, mentions that a turning point for this market would be "extreme and unsustainable valuations as growing investor confidence turns into over-optimism and complacency."

Fiverr

Has the market reached this point? The article answers: "This seems implausible, for two reasons. First, because standard valuation metrics are only just above their average levels in the United States and lower than average in most other markets — a point made repeatedly by Federal Reserve Chairwoman Janet Yellen and explained in my recent article on valuations …

"Second, because the market's behavior itself confirms that today's valuations are not unreasonably elevated. If valuations were genuinely over-extended, investors would have sold equities far more aggressively in response to such pressures as the Fed's tapering of bond purchases, the stalling of U.S. growth last winter, the disappointment (yet again) with European economic prospects or the conflicts in Iraq and Ukraine."

This is an interesting analysis, though not necessarily true. The US "plunge protection team" probably has more short-term clout than most individual investors. If the "team" doesn't want a downturn, it can probably forestall one, at least in the short term. And then there is flash trading that makes up perhaps 50 percent of market volume.

While the article goes off the rails here, it recovers with the conclusion that "If stock market valuations are not yet high enough to cause a big correction – and if monetary and economic conditions are likely to remain benign for the next year or two – then the unavoidable conclusion is that equity prices will just keep rising until they really do become over-extended."

Yes, the crash is being forestalled and forestalled until it is inevitable. It is being cultivated like some sort of gigantic hothouse flower. When this market finally breaks, it will be with a resounding crash that may echo throughout history.

We've rehearsed the reasons many times before. Regulatory changes have concentrated and expanded both investor participation and the amount and kind of offerings that can be provided to buyers. Then there is monetary policy that is entirely crazy. Around the world, central bankers have pressed monetary accelerators to the floor in a race to print as much currency as possible.

The world is swimming in the money: A "correction" may be a serious possibility – even a crash such as which happened in 1987. But the 1987 crash in retrospect was not a 1929-style disaster but a temporary setback, for the market rebounded and made new highs in the 1990s, and then beyond.

This Reuters article provides a good many surface reasons why markets are continuing to make progress in the long term. Of course, it avoids the real reasons, which is that markets have been strenuously organized to rise. But we aren't really supposed to talk about those reasons. The job of the mainstream press is to rationalize market rigging by avoiding reporting on it.

We'd rather incorporate larger market influences – and corruption – into our analysis. But we reach the same …

After Thoughts

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