WHAT is inevitable and what is possible are poles apart in meaning and conceptual construct, more so when predicting the behavior of financial markets, particularly the stock market, as Charles Dow, who developed the Dow theory of technical analysis nearly 100 years ago, and William Hamilton, who refined it, readily acknowledge that their hypothesis does not guarantee a win over the market.
In the Lombardi Letter sent to subscribers on March 28, 2017, economist and market analyst Michael Lombardi notes that signs are pointing to what most stock traders, brokers and investors usually don’t want to see. “Three key indicators are saying that a stock market crash in 2017 is a real possibility. Warning bells are ringing for the historically correct price-to-earnings (P/E) multiple, stock market margin debt and investor sentiment.”
In other words, stock valuations are too high and investors are behaving badly by ignoring the signs and borrowing to much money to trade. Lombardi’s reference point is the US market. But, as the saying goes, when the US economy sneezes, the rest of the world catches a cold.
This year marks the 10th anniversary of the bursting of the housing bubble in the US and UK that spurred a global financial crisis. Online financial content provider Investopedia noted the S&P 500 declined by 57 percent from 1,576 in October 2007 to 676 in March 2009. Unlike the 30 most valuable stocks represented by the Dow Jones Industrial Average, the Standard and Poor 500 tracks the 500 most widely held stocks on the New York Stock Exchange and represents roughly 85 percent of the total market capitalization of listed companies in the US.
This 10-year boom-bust market cycle may not be obvious until the 1997-1999 Asian financial crisis comes to mind: a foreign exchange disaster in Thailand erupts into a full-blown financial crisis and spreads to Malaysia, Indonesia and the Philippines. The crisis then reached South Korea, Hong Kong and China, and turned out to be a global financial meltdown. By 1998, the economies of Russia and Brazil were in a tailspin. Soon, stock markets from New York to Tokyo plunged into record lows. Investors, from the day trader to the long-term fund managers, came to realize how financial markets are truly volatile and unpredictable.
StockCharts.Com noted, citing Hamilton and Dow, there is no way of telling accurately where the market is headed for. “Trying to predict the length and the duration of the trend is an exercise in futility.”
Before the Asian financial crisis, there was the crash of October 1987. Jennifer Itskevich, a student at Rutgers University and an intern at History Network News, captured the essence of what happened. “In the days between October 14 and October 19, 1987, major indexes … in the United States dropped 30 percent or more. On October 19, 1987, a date that subsequently became known as ‘Black Monday,’ the Dow Jones Industrial Average plummeted 508 points, losing 22.6 percent … The S&P 500 dropped 20.4 percent, falling from 282.7 to 225.06. This was the greatest loss Wall Street had ever suffered on a single day.”
The beauty of financial markets is in their ability to recover from collapse, because markets are made up of traders, analysts, brokers and investors who are actually people wired to get back on their feet after a crash.
Financial markets really are game for the moneyed with cash to spare and lose or attract some more, depending on market direction and their tolerance for risk or greed, as the case may be. There is really no way for the government to regulate and prevent a market crash, especially in a free market economy.
As Lombardi implied, greed is a common factor ahead of a crash. How does a government regulate greed? And if regulation is the answer, wouldn’t it have been done long ago?
Lessons from a market meltdown may be too painful to bear, especially for small investors—the teachers, the retirees, the overseas Filipino workers who make up a large segment of individual players lured by prospects of financial success.
Not all is lost though. Knowing when to get out while still ahead of your stock position before prices collapse is the most productive lesson to keep in mind, not digging in on the false hope that the market will rebound soon.