Stocks dive so will there be a real crash in financial markets this October?

Posted on 05 August 2011 with 3 comments from readers

Yesterday was the worst day for US financial markets since the crisis of December 2008 so you could argue that the stock market crash is already upon us. That might prove true but a more gradual shake-down in stock prices until a market rout in October would still be a valid historical parallel.

The parallels between this summer and 2008 are very significant. Then it was the overspill from the subprime mortgage crisis that gummed up the global credit system.

This time the eurozone sovereign debt crisis is the cause of rising bond yields and a gradual freeze in inter-bank lending in the PIIGS countries. Once this contagion grips it can spread like wildfire.

2008 precedent

Central banks know this of course but that did not stop us falling into the global financial crisis of late 2008 with a rebound and then a ‘final’ low in March 2009. The ECB is also not the Fed. Will it be any different this time?

To be sure stock markets look toppy again. Profits are presently at the peak of their cycle, and even absent the eurozone sovereign debt crisis this would be an issue for stock valuations.

Yesterday stocks slumped and the ArabianMoney short ETF portfolio gained 15 per cent (sign-up for the newsletter here to get the portfolio). We have seen this coming albeit our initial warnings were way too early.

Put at its simplest as corporate profits fall so do the value of shares, so falling profits is a slam dunk for a downer in the stock market. Timing that downer is always more difficult as it depends so much on the animal spirits of investor sentiment.

However, global confidence surveys recently have been turning more negative so that suggests time is running out. Mr Market has certainly got a bad attack of nerves over the past month.

Is Mr Bernanke waiting in the wings with QE3 to cheer Mr Market up? No doubt there is a QE3 in preparation but it could be that this weapon is kept back until things look particularly desperate or it will be wasted.

Pre-emptive QE3?

The danger of a pre-emptive QE3 is that it has about as much impact on markets as raising the US debt ceiling this week which sent stocks up for an hour or two at the most. But used at the right moment QE3 could rally markets and prevent a drop into oblivion.

For few people really seem willing to acknowledge just how serious the global economic situation is this summer. We almost had an apocalypse in financial markets three years ago and now there is a new crisis at hand that is going to take us back to the brink again.

All this does seem a formula for a financial market crash in the traditional black month of October, and perhaps the politicans would rather like to get it over and done with then, rather than interrupt the US presidential election year.

Ominous chart

You would expect to see ominous warnings of an imminent stock market crash in the technical charts and we note this ominous chart for the S&P below as annotated by the first-rate analyst Clive Maund.

He says we are at the ‘cusp of a catastrophic breakdown, for if the support at the bottom of the potential head-and-shoulders top fails, and the heavy volume driving the decline of the past week suggests that it may, it will usher in a brutal bearmarket decline, and given the now dire fundamentals, possibly a crash.’

Anybody watching stocks crash yesterday will know how Clive Maund’s forecast played out!