US Federal Reserve building

Money and markets: who is to blame for the stock market’s imminent crash?

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We are on the edge of another global stock market crash. If it happens, then many people will get the blame, but there’s just one cause at which we should point the finger.

General Electric, one of the giants of engineering, is having a hard time. It has been unwinding a lot of history, slimming down and tidying up its legacy. The market is punishing it for its actions, with the once glory stock halved in price this year. This may well be an omen for things to come in the broader market.

To quote the American wit and sportsman Yogi Berra: “It’s tough to make predictions, especially about the future.” However, as I write, we appear to be at the beginning of the first stock market crash in ten years.

From a financial engineering perspective, markets are random and returns are normally distributed. The future is a ‘Markovian chain’ where links from the past do not influence the future. This is an unpopular idea among people who give stock market advice as it makes them out to be little more than witch doctors. Nonetheless, I am donning my head-dress and waving my rattle.

In normal times it is hard to fight this idea that it is possible to predict the future of the market, but the reality is that the markets are highly random and that the non-random element is only a tiny signal buried in a whirling hurricane of noise. When you apply a bit of science to this you can ‘signal process’ the noise and what is left behind is usually little use for the hungry trader as the predictability is too small to capture a profit with.

The small signal that is left behind is usually only of use over long timeframes the markets don’t care about, which is why super-long-term investors, like Warren Buffet, can use this to their advantage to become fabulously wealthy.

Now here we are on the edge of a global markets precipice, potentially about to tip into a crash.

If this occurs, people will get the blame. The culprits will be Mark Zuckerberg for letting data out of Facebook be surreptitiously used to influence elections, the Uber bosses for wrecking the prospects of self-driving cars which will skittle the stock prices of Nvidia, Tesla and anything vaguely connected with future car-tech. President Donald Trump will be blamed for causing the crash by inflaming trade wars and whacking tariffs on steel and aluminium and, as the market falls, the hue and cry will be raised for scapegoats. People, not circumstances, will be blamed.

However, the real cause will be reverse-QE (quantitative easing) coming out of the Federal Reserve in the US as it tries to dismantle its multi-trillion dollar balance sheet and get it back to the much lower levels of normality prior to the global financial crisis of 2007-2009.

The trillions of dollars of liquidity pumped into the market via QE in the US, Japan, China, Europe and the UK are responsible for the global market’s heady heights, the amazing valuations for the tech darlings around the world, high real estate prices and the rampant asset inflation of the last ten years. It shouldn’t take a mathematician or engineer to figure out what happens when the flow is reversed.

As of last autumn it has reversed. Starting September 2017, reverse-QE kicked off at $10bn with a target to ramp up to $80bn a month by next November, running until $2-3tn of assets are sold back to the world. This is a huge drain of cash, over 20 per cent of US M2 money supply.

Three months after the process began, the wheels came off the global stock markets, decisively breaking the historically smooth rise of US and world stocks that had been running for years. While people are being named and shamed in the broader market for this sudden reversal of fortune, it’s not them; it’s reverse-QE that has holed the market below the waterline.

Companies of the world have come to rely on cheap money and the ‘ZIRP’ (zero interest rate policy) funding the system. As GE is humbled by its convoluted finances, it is just a taste of what will unfurl if interest rates rise quickly and/or liquidity is withdrawn faster than economies can accommodate.

If the Fed ploughs on with reverse-QE the market will crash; if it does not and interest rates rise in any event, a similar outcome will follow only later, then, if a crash causes monetary loosening again, the bogeyman of inflation is set to emerge.

The world economy has reached a pivot point, the trend is broken, so what happens next?

Stock charts predict the past, and until the wild swings we see in stock indices start to die down we will know that we remain on the cliff edge of another stock market crash, then economic recession.

Stock markets crash, they always have and they always will. If this is another then the cycle of crash, recovery, boom, bubble and bust will begin again.

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