Sunday, May 21, 2006

Market Conditions Are Just Like 1987 Before The crash

Rough seas ahead in the markets according to the Sunday Times:

CONDITIONS in the financial markets are eerily similar to those that precipitated the “Black Monday” stock market crash of October 1987, according to leading City analysts.

A report by Barclays Capital says the run-up to the 1987 crash was characterised by a widening US current-account deficit, weak dollar, fears of rising inflation, a fading boom in American house prices, and the appointment of a new chairman of the Federal Reserve Board.

All have been happening in recent months, with market nerves on edge last week over fears of higher inflation and a tumbling dollar, and the perception of mixed messages on interest rates from Ben Bernanke, the new Fed chairman.

“We are very uncomfortable about predicting financial crises, but we cannot help but see a certain similarity between the current economic and market conditions and the environment that led to the stock-market crash of October 1987,” said David Woo, head of global foreign-exchange strategy at Barclays Capital.

Apart from the similarities in economic conditions, during the run-up to the 1987 crash there was a sharp rise in share prices worldwide and weakness in bond markets, Woo pointed out. “Market patterns leading to the crash of 1987 resemble the markets today,” he said.

Equity markets settled on Friday after sharp mid-week falls, with all the main American stock-market measures recording small gains on the day. But nerves remain.

The Dow Jones Industrials fell 22.6% on Black Monday, October 19, 1987.

If the Dow Jones falls 22.6% on Monday, the market would go from 11,144 to 8,626.

Now obviously I'm not saying the Dow Jones is going to crash like that on Monday. But if the conditions in the markets are just like October 1987, then this kind of percentage loss could happen in the near future.

And how would the American economic house of cards, already teetering under the weight of massive government and individual debt, high energy prices, and rising inflation/slowing growth, react to that kind of market crash?

I'm surprised the current dynamic hasn't generated panic already.
The saving grace, perhaps, this time around is that the big creditors, China and Japan for example, can't afford to see the US economy collapse.
They have done all the right things, but they are exposed. The big question is. can they head off a collapse.
Both took the 'dollar store' option in their various sectors - China quite literally dollar store goods and Japan in cheap loans.
They could find themselves too exposed on the volume over margin approach.
It is a worry.
I think many Americans have this wonder ability to engage in "magical thinking" and believe that a negative savings rate snd astronomical amounts of credit card and mortgage debt won't come back to haunt them.

It's the same kind of magical thinking that allows a little kid to close his/her eyes and believe nobody can see him/her.

It is a worry. I don't know what the solution is. I'm not sure anyone does.
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