Coward Old Universe…

by Jeremy G.

Will Markets Crash Next Thursday?

Posted by Jeremy Ghez on October 24, 2006

 

fincrisis.jpg

 

 

Whatever goes up must come down, or so goes common wisdom.  One unfortunate application of this generally accepted law is the evolution of stock markets, whose inexorable rise these past days – or is that wishful thinking? – have made FOX commentators and investors more than enthusiastic.  The question is not whether or not this expansion will last – American markets have not undergone any correction since the 2003 drop following the US intervention in Iraq – but when will the trend inverse.

 

Already, last August, brilliant economist Nouriel Roubini, head of RGE Monitor made very disturbing comments regarding the current state of the economy and the financial markets, noting the troubling similarities between 1987 prior to the market crash and current times.  There are several “Scary Similarities between 2006 and 1987”, said Roubini, among which:

 

 

  • A new chairman took office in 1987, just as in 2006.  Like Greenspan in 1987, Bernanke must deal with market skepticism and criticism regarding an interest rate policy that does not seem to create a real consensus.

  • Both times are characterized by concerns over rising inflation, leading Bernanke in 2006, just like Greenspan in 1987, to raise interest rates in the context of global economic uncertainty.

  • Both Fed heads have demonstrated their difficulties, in the early days of their mandate, to communicate efficiently with financial markets, thus increasing all the stakeholders’ nervousness.

  • Both periods share the negative perception of the rising American deficits – which was actually the trigger of the 1987 October Crash.  Similar tensions with China make Roubini’s argument all the more so compelling.

 

Roubini’s conclusion gives more chills than any of Tom Clancy’s opening chapters:

 

 

 

This is a toxic and combustive mix of volatile elements that can lead to a financial explosion and meltdown. And it may take any small match to trigger it: a trade war scare mongering, scorning the foreigners that finance you with restrictions to inward FDI, talking down the dollar to bully China and the US trade partners, a flip-flopping monetary policy, a further spike in oil prices, an event of terrorism or a wider Mid East conflict,  a housing market rout rattling the MBS market, the collapse of a large and systemically- relevant hedge fund or of another highly-leveraged financial institution, a Chapter 11 event for a major US corporation such as Ford or GM leading to systemic  effects in the credit derivatives market

 

 

This argument was made two months ago.  During the period, the Dow Jones soared, and reached historical levels, past the 12,000 mark.  So what’s up with Roubini’s logic?

 

My intuition is that we have not seen anything yet, as, historically, violent turnarounds tend to occur on financial markets during the months of October, and especially on Thursdays.  There is nothing cabbalistic or esoteric about that point.  Recent research in finance and economics ( Morris and Shin (1998) and Abreu and Brunnermeier (2003) being the most compelling cases) has shown the role played by news events and political and economic announcements- and I would personally add to the list symbolic days or dates – can rationally serve as synchronization devices for financial investors who believe the bubble will burst, but who wish to coordinate with others their sales.  As the other saying goes on financial markets, “it’s no use being right all alone when you can be wrong with everybody else”.  Fundamentals do not matter anymore at this point, if the assumption is that this is a bubble.  In this context, if I am an investor wondering when other investors will decide that enough is enough, and if all agents are probably thinking similarly, I will be looking for a specific time to synchronize my decision to sell.

 

Everybody knows that Thursdays in October tend to be dreadful days for financial markets.

 

The only problem remaining is that there is only one Thursday left in October in 2006…

 

 

 

 

PS: Stock markets didn’t crash.  In my defense, a smart person once said that an economist is “the guy who’ll tell you tomorrow why what he predicted yesterday did not occur today”…  I was wrong…  Maybe I’m just becoming a great economist…

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