Tuesday, 22 March 2016

Will Financial Markets Crash Tomorrow?

There have been numerous suggestions from financial analysts that financial markets have become very expensive, and that March was likely to see a peak in valuations. Some have been more specific, about when that peak might arrive, and as I reported a while ago, one contributor to CNBC even predicted that the peak would come at 2.00 p.m. tomorrow. So, are markets likely to crash tomorrow afternoon? Probably not.

There is no doubt that global financial and property markets are grotesquely inflated. They have been repeatedly blown up over the last thirty years. But, the fact that these markets are in a bubble does not mean that the bubble is going to burst tomorrow. After all, they have been in a bubble for a long-time, and it hasn't burst yet. As Keynes said, financial markets can remain irrational for much longer than the average speculator can remain solvent. In 1996, Federal Reserve Chairman, Alan Greenspan, commented that he thought financial markets were suffering from “irrational exuberance”, yet they did not crash for another four years, in March 2000. Part of the reason for the irrational exuberance, and the reason that irrationality continued until then was, of course, the very policies that Greenspan was pursuing, what became known as the “Greenspan Put”, as he cut official interest rates, and relaxed monetary policy, every time the stock market dipped.

When markets crashed in March 2000, the Sunday Times, ran stories arguing that it would take twenty years for them to recover. In fact, already by 2008 the Dow Jones 30, and the S&P 500 had recovered its previous 2000 levels. Whilst the NASDAQ, which had been the worst hit index in 2000, falling by 75%, did not achieve that, even it had broken its 2000 highs, by last year. Similarly, having soared after 1997, there were numerous predictions that the UK housing market was in a bubble that was set to burst, from around 2003. Yet, that bubble continued to inflate until the financial crisis of 2008 led to it falling by 20% overnight, before that fall was halted by Gordon Brown and the Bank of England's intervention. So, there is nothing about the fact that financial and property markets being in such bubbles that means that the bursting of those bubbles can be predicted with any degree of confidence. All that can be said is that bubbles always burst.

And today, we have bubbles everywhere you look, of proportions greater than at any previous time in history. There are clear signs that markets want to fall. Over the last three years there have been a number of large falls in markets, but each time the corrections have been relatively short, and have been more or less recovered in following rallies. There was the so called “taper tantrum” when the Federal Reserve announced that it was going to start reducing the amount of QE it did, then when they announced the likelihood of starting the process of raising official interest rates, there was another sell off in the middle of last year, resulting in the rate hike being deferred until December. Then there was another sharp sell off in January, leading to the Fed issuing calming words over the path of further hikes, and deferring any March hike. 

There is no reason to believe that the period ahead will not follow that pattern of similar such periods in history, and that we are in for a gradual rise in the average rate of interest, and for a thirty year period during which financial and property markets fall in real terms. Such periods are never characterised by a simple smooth decline, but by sharp declines as bubbles are burst, followed by periods of recovery and stability, followed by further declines. At some point in the not too distant future, a crash will occur, but its unlikely to be tomorrow.

The reason for that has to do with human behaviour. Think about people going to a nightclub. They pay out a chunk of change to go to some nightclub that they have been told is very popular. When they first arrive, there are not many people in, they begin to wonder whether they have made a mistake, as there is little atmosphere. Gradually, it fills up, and they feel more confident in their decision, as things start to get into the full swing. But, then it starts to get rather overcrowded. There is no room to dance on the dance floor; no one dare move from their seat for fear of losing it; it takes ages to get served at the bar; everyone squeezes against everyone else, and the atmosphere becomes hot and sticky. What is worse, everyone begins to think that its so overcrowded that it has become dangerous.

Yet, no one, having paid to enter, wants to be the first to leave, because that would mean losing out on what they had paid for, and also that it would mean that those who remained would benefit from the less cramped conditions, after others had left. The consequence is that it becomes more and more overcrowded, until a fire breaks out, and everyone rushes for the doors, at the same time, resulting in chaos, people dying from being trampled and crushed and so on.

Of course, had there been perfect knowledge so that someone would have said in advance that a fire would break out at 11.00 pm., the chaos would have been averted, because everyone would have ensured that they were out of the building before it happened. But, unless its an act of arson, no one does have such knowledge of when a fire will break out. Similarly, as the market traders say “No one rings a bell when the top of the market has been reached.” So, people continue to pile into the market, and only rush for the exits when its too late, when the peak has been reached, and the crash is underway. In fact, its usually the professional traders, and the big money-lending capitalists who get in, when its not overcrowded, and when prices are cheap, and when the ordinary retail speculator is staying away from the market, having got their fingers burned in the last market crash. Its only when prices have been rising for a long period, that the ordinary retail speculator decides they want some of the action, and begins to put more money into their Equity or Bond ISA, or decides to become a Buy To Let, property speculator, i.e. at just the time they should be staying away.

But, its for just that reason that a market crash tomorrow is unlikely. Everyone knows that these markets are grossly overpriced, and there have been lots of warnings that the markets are going to crash – similar warnings were issued by the FT and others at the end of 1999/start of 2000, but no one wanted to listen – which means that lots of money is likely already to have been taken out, just in case, just as people would leave early if they knew a fire was going to break out.

Of course, that doesn't change the fact that all of these stock, bond, property and other markets are grossly inflated, and that these bubbles will burst. One of my friends was telling me recently about the high prices for vinyl records. Its just another aspect of the extent of these bubbles, as speculative money has continually looked for the next thing that might provide large, quick capital gains, whether its, gold, silver, wine, art, bitcoin, or whatever. When the bubbles burst, they will all burst together.

So, a crash tomorrow is unlikely, but that doesn't mean it will not happen next week, or the week after that, when no one expects it, just like people get crushed in an overcrowded nightclub, when a fire breaks out unexpectedly. But, unlike 2008, when I forecast the financial crash was about to break out, I see no imminent catalyst for it, and such a catalyst is almost always necessary to spark the crash. There is undoubtedly some severe stress in global junk bond markets, where yields have risen sharply over the last few months, and where the cost of insuring against default has risen sharply. That is particularly the case in the energy sector, which accounts for about a third of the US junk bond market. The sharp fall in oil prices means many of the smaller energy companies that have raised money-capital by borrowing in the junk bond market, are in danger of collapse, and of defaulting on their bonds, with a consequent effect in the wider bond and financial markets. But, so far none of those companies appears to have defaulted to the extent of provoking a crisis, and the more recent rise in oil prices has relieved some of that pressure, whilst creating other pressures.

Another catalyst could be a renewed series of corrections and collapses in Chinese financial markets, which spreads into global markets. Other sparks could be Brexit, but in addition, there is a growing awareness amongst global policy makers that monetary policy cannot provide any solutions to global growth. Even central bankers are now openly stating that governments have to begin a process of fiscal stimulus, particularly in relation to infrastructure spending. They do not yet seem to have forced themselves to recognise that QE has actually been damaging to economic growth, rather than beneficial.

As it begins to sink in that financial markets are on a long downward trajectory, and that the days of guaranteed, large-scale capital gains are at an end, so the fact that near zero yields are the cost of those previous capital gains will begin to sink in, and the owners of that money-capital will begin to look for alternative uses for it. As Marx put it, 

“If an untowardly large section of capitalists were to convert their capital into money-capital, the result would be a frightful depreciation of money-capital and a frightful fall in the rate of interest; many would at once face the impossibility of living on their interest, and would hence be compelled to reconvert into industrial capitalists.” (Capital III, Chapter 23)

In other words, say the rate of profit is 10%, a money-capitalist may then be prepared to lend money-capital to a productive-capitalist at 3%, which they obtain either as interest on a bank loan, coupon on a commercial bond, or in the form of dividends on shares. That leaves 7%, as profit of enterprise for the productive-capital. If, however, more and more capitalists become speculators, ploughing their money into the purchase of corporate bonds, or shares, the prices of these bonds and shares rises, so that yields on them falls. These speculators may be prepared to accept near zero yields on these bonds or shares, if they think they are making large capital gains. If that no longer appears the case, and indeed it becomes more likely to make capital losses, they are unlikely to continue to accept near zero yields on the money-capital.

Instead, they will look around and see the potential for making 7-10% profit on their capital, if they employ it directly themselves as productive-capital, and will thereby turn themselves once more into industrialists, using their money to buy buildings, machines, materials and labour-power, rather than buying bonds and shares. That in itself will cause the prices of bonds and shares to fall, and interest rates to rise.

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