Doomsday prophecies haunt financial markets

October is SOON and the month can make any stock investor sweat. What is well known is the Wall Street meltdown of 1929, which began on Thursday, October 24th, and culminated the following Tuesday, October 29th.

My first professional experience of a stock market crash was in 1987. On “Black Monday,” October 19, the Dow Jones stock index fell a famous 22.61 percent. Interestingly, the Dow’s second-biggest daily decline, recorded on March 16, 2020, down 12.93 percent, is due to the Covid-19 pandemic. For completeness, in 1929 the total loss on October 28th and 29th was 24.55 percent.

Current predictions

Stock investors are haunted by numerous doomsday prophecies about new market falls of up to 35 percent. It happens before October every year, but I totally agree that there are many uncertain variables that can be affecting stock markets right now.

In addition, the US investment bank Goldman Sachs has published a very accurate assessment of the current stock market. More specifically, it argues that the rise since June 22nd is what is known as a bear market rally, a major correction in a protracted bear market. Based on historical data, the correction will last 44 days before resetting the losses, says Goldman Sachs. The bank’s analysis involved some interesting models it had developed combined with a very classic argument that the American economy is close to recession. Those are valid arguments, but what I think carries a lot of weight is simply the fact that Goldman Sachs has ties to virtually every major fund and investor in the world and always listens to what the bank says.

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Many predictions about the stock market are largely based on past price developments, but of course these are also linked to macroeconomic factors. My assessment is that economic history repeats itself and one can learn from it. For example, some of the causes of inflation have been the same for several hundred years. But the financial market never repeats itself exactly and therefore I do not only use past price developments as a basis for predicting the future development of the financial markets.

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Learning from the past

It is natural and incredibly important to incorporate the accumulated experience of the financial market. It is the holistic and combined insight that one needs when looking into the crystal ball. It can be challenging, but these assessments are exciting.

In this context, it is important to jump back to the beginning of this column. The 1987 crash was due to the stock market going too far, so I’ll argue that it was a normal bubble that burst. Despite the huge one-day price drop, the crash didn’t have a major impact on most economies around the world. Meanwhile, the 1929 crash coincided closely with macroeconomic developments and, I believe, with both political and broader societal developments.

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Unfortunately, there are several developments today where one can find the same pattern from 1922-1929. For me, this is cause for concern, but it doesn’t make me rate the risk of a similar crash as particularly high.

My assessment remains that the financial markets will correct. It’s a severe correction, but not a crash or the prelude to a final and all-devastating crash. Throughout the western world, interest rates that have been too low for many years have to be corrected upwards, and that hurts. In addition, some energy prices in Europe also need an upward revision as they have been unnaturally low for at least a decade and Europe is currently paying a heavy price for this.

A correction means that the financial markets have bottomed and there is life after the correction. There will also be a time after a possible recession, but it will be a different world than it is today – a story to be found in a future column.

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