Chatter in some parts of the unconventional financial press online is increasing, citing investors such as Jim Rogers, that the U.S. stock markets will collapse by 50 – 80%. Parallels are being drawn to the market collapse that began the Great Depression in 1929, the 1999 collapse after the technology bubble burst, and the 2007-08 collapse after the housing bubble burst. Even some conventional economists, including the Bank of Japan, seem to be of the view that the prolonged period of low interest rates, if continued, could lead to market instability and the major central banks worldwide have changed their bias to tightening monetary policy, though it must be pointed out that such bias has arisen because of improving global growth outlook and reflation. Still, it would be useful to compare and contrast the current economic context with 1929, 1999 and 2007-08 to understand if indeed prophecies about a market collapse will materialize.
Leading up to the Wall Street crash of October 1929 were downtrends in commodity prices and industrial production which caused the stock market to fall by 10% by September into correction territory. The stock market bubble that was created in the 1920s preceding 1929 was fueled by hundreds of thousands of people buying stocks with borrowed money. This led to panic selling toward the end of October and put the markets in bear territory. Between 1929 and 1932, the Dow Jones Industrial Average (DJIA) fell by 89% from its peak before selling began in 1929 sinking the U.S economy into a depression. Of course, the U.S. Federal Reserve made the well documented mistake of raising interest rates by contracting money supply thinking that less money in the markets would defuse the stock bubble, causing a string of bank failures from bank runs, turning what was a market correction and recession in 1929 into a full blown depression by 1932.
The bursting of the technology dot-com bubble in 1999 was caused by significant investments in information and communications technology (ICT) firms to commercialize the internet without regard to return on investment in a specific time frame. Moreover, few large ICT firms engaged in illegal accounting practices which exaggerated their profits. The tech-heavy NASDAQ fell by as much as 78% after the dot-com bubble collapsed. The Federal Reserve, unlike in 1929, lowered interest rates and more so after the September 11, 2001 (9/11) World Trade Center (WTC) terror attacks to cleanup after the bubble collapse and to uphold the U.S economy in the wake of the geopolitical uncertainty caused by 9/11, leading only to a short recession.
Central bank response worldwide to the 2007-08 implosion of the housing market has been, though a bit delayed in its scale initially, on a war-footing to prevent a recession turn into a depression as in 1929, though the markets fell by 50%. Major banks had committed fraud by selling unstable housing securities packaged as newfangled investment instruments knowing full well that if the interest rate environment changed these instruments would lose considerable value because of foreclosures in the underlying housing market. The banks that failed had little or no cash cushions and the major banks which were systemically important relied on the Federal Reserve to bail them out. The recovery from the recession which began in 2009 has been slow partly because fiscal policy did not support the monetary easing due to fiscal austerity measures adopted by most governments including the U.S.
The review of the above oft cited market collapses shows that the determinants of crisis are currently non-existent. There is no bubble in any market and U.S is near full employment. Earnings and earnings forecasts of major corporations are healthy and their stock prices – unlike in 1929, 1999 and 2007 – are reflective of healthy performance but not of any bubble. U.S non-financial corporations are sitting on about USD 1.7 trillion cash pile as of 2016 though corporate borrowing in the commercial paper market has gone up due to low interest rates. U.S banks have excess reserves of more than USD 2 trillion at the Federal Reserve.
China’s economy is stable but slower as intended due to timely government policies despite its stock market crash of 50% which did not involve a large segment of China’s population. Debt in U.S and China is manageable and will not cause a crisis. The European Union (EU) is growing at an annual rate that is better than U.S. growth. Japan is back on the growth path (though the growth is slow) even as it addresses its lack of inflation problem. Indian growth, though it slowed a bit because of demonetization, is strong and is forecast to be strong. But for Russia, South Africa and Brazil, the rest of the world economy is on the mend. Commodity prices, including that of oil, are rising again due to rise in global demand and this could help bring Russia, South Africa and Brazil out of their economic funk.
Monetary policy, despite a tightening bias among the major central banks worldwide, is still accommodative, and after the election of Donald Trump in the U.S there are hopes of fiscal easing both in terms of tax policies and higher government spending. Most importantly, the outlook for global gross domestic product (GDP) growth – despite political uncertainties such as Brexit, the election of Donald Trump in the U.S, and the rising political fortunes of the nationalists in Europe – is positive and encouraging.
Any talk of a financial market collapse in 2017, given the evidence, is thus not verifiable in data.