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Article by Alex Repeta
Since the Lehman Brothers filed for bankruptcy on September 15, 2008 prompting a global financial panic, both investors and economists alike have operated with a chip on their shoulder. With more than $600 billion in assets at the time, it was impossible for the average Joe to comprehend how an institution as renowned and respected as the Lehman Brothers could have filed for bankruptcy. With this in recent memory, and the economy’s tendency to repeat itself, many are forecasting another financial crisis in the near future.
To comprehend the crisis of 2008 in its entirety would require an extensive amount of research and understanding on the topic. In short, the series of events was built on an extremely unstable foundation of irresponsible mortgage lending. In 2007 at the height of the then US economy, banks started to issue loans to ‘subprime’ mortgages (Origins). The term ‘subprime’ was used to describe borrowers with poor credit history, essentially a person incapable of paying back the loan given their current state. These loans were handed out to almost anybody who asked and drove property buying sprees by people who were unfit to handle the financial obligation that came with it. Near 2006, banks began to realize that they could not collect from their borrowers as one by one they declared bankruptcy, leading to a country-wide housing recession. Soon after the collapse of the housing market, the effects of it reverberated to Wall Street ultimately culminating in the worst recession that the US had seen since ‘The Great Depression’ of 1929 (Origins). The falsely valued mortgages were injected into the market as tangible assets called mortgage backed securities. The securities were supposedly driving economic development, but as we know now, it held no monetary value (Lokeshwarri). This money that was spent in the stock market disappeared creating massive debt for almost all. The US economy came to a screeching halt, scaring away investors. The US hit rock bottom in 2009. The movie, The Big Short captures and explains the situation of the economy at the time in a very insightful way for those interested.
With all of this in recent hindsight, investors are still cautious of the 2008 market woes. What’s more is that research conducted by many economists point to the fact that the economy operates in a cyclical manner, experiences a downturn every 7-8 years (Lokeshwarri). Considering that the most recent crash occurred in 2008, we are theoretically overdue for our next recession. 1975, 1982, 1991, 2001, 2008, are all years that have experienced a downturn in the market. Technical and numerical analysis are hard to argue against in a purely value oriented market where almost everything can be expressed as a number.
However, numbers are not everything and these cyclical ‘trends’ can all also be explained qualitatively. The 1991 recession was brought on by the massive exodus of the baby boomers in the labor force, and in 2001 the dotcom bubble collapsed due to too much speculation on the internet (Tankersley). 2008 as we know was caused by irresponsible lending of capital to ‘subprime’ borrowers. Qualitative factors act like a catalyst of the numbers that define the economy. Numbers always support the outcome of the market but are most likely just a tangible extension of these qualitative factors. So to predict an impending stock market crash, there is a need to identify a reason in the economy for the market to potentially compromise itself. Considering the tightknit connection of politics and the economy, the latest theory incorporates recent US President-elect, Donald Trump.
Since Trump’s “underdog” election win, the Dow Jones Index, a compilation of the 30 large publicly owned companies based in the US, spiked an unnatural 2,000 points in a mere 6 months (Dow). This spike indicates a 12.7% increase, an unprecedented level of growth. The market saw more exponential growth of 7% to a historical high of $ 21,115.55 in a matter of a month triggered by Trump’s inauguration on January 20 of this year (Dow). The extraordinary jump in value has been coined as the ‘Trump rally’ (Yastine). Other indices such as the Standard and Poor (aka S&P 500) and Russel 2000 within the US turned bullish (a term used to describe a growing economy) as well. While Donald Trump’s policies support growth and promises to rejuvenate the US work force, his policies cannot account for this kind of exponential growth. Economists summarize the state of the current stock market with one word; overvalued.
To say the least, it would be incredibly hard to sustain the level of capital transaction that is happening in market right now. As we all know, companies issue shares of their stocks to be bought by interested investors. The face value of the stock is what we see quoted as ticker prices and is what is used to determine if a company is doing well or not. If stock prices are inflated with no basis for inflation, such as an increase in revenue or expansion, then the stock can be said to be overvalued. Any form of overvaluation cannot be sustained and will eventually yield a market reaction of prices tanking or what is called a ‘crash’ of the stock market.
The state of overvaluation can potentially be applied to the current situation of the US. Initial optimism on Trump’s economic policies and promises created consumer confidence in the market and capital transactions increased exponentially. The stock market works on the simple concept of investor confidence as well as supply and demand, where more confidence drive stock prices up and vice versa. What these concepts imply to the current situation is that the market as of now is operating at a record high level of trades and that the value of some companies are greatly inflated by the investor confidence. Whether the current level is stable or not will be determined if the market can stand the test of time. But as of now, many are in agreement that the market will correct itself in the near future, in other words, a recession is headed our way (Lokeshwarri).
As if that wasn’t scary enough, James Dale Davidson, the famed economist who correctly predicted the stock market crashes of 2001 and 2008, has recently said that a recession is “… already at our doorstep” (Yastine). He has emphasized that it was a matter of when, not if, and suggested a 50% potential downturn in an interview with the Sovereign Investor. In light of this, Warren Buffett, a renowned investor, has slowly withdrawn $55 billion from the market over the last couple of months looking onward to when the market does eventually correct itself (Buffet’s). From the six grand that he started with when he was fourteen, his wealth now exceeds $70 billion (Langlois). His word carries a lot of weight in investing matters and this decision of his is no exception. The confidence scale of the market has started to tip, yielding a lower volume of transaction recently.
While a specific date cannot be pinpointed in a matter so volatile and unexpected, a market crash is most definitely on the horizon due to the simple fact that recessions are an integral part of the cyclical nature of any economy. 2018 if not 2017, 2019 if not 2018, but a downturn is unavoidable and the further the issue is prolonged, the harder the economy will fall.
Buffett’s $55 Billion Gamble is a bet on the U.S. Collapse, Warns CIA Economist.
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