Return of volatility in global financial markets is the best indication that a crash is comingPosted on 02 June 2013 with no comments from readers
Low volatility in financial markets generally coincides with a market top. Conversely markets are most volatile when they hit the bottom. The sign that one type of market is beginning to morph into the other is a bout of increased volatility.
Is that not what we saw last month? The second largest stock market in the world lost nine per cent in an interday flash crash and ended the month in an official correction. US T-bonds paid their highest yields in three years as investors flirted with the idea that the Fed will end its money printing program QE early. US stocks sold off suddenly in the last hour of trading last week.
So what’s next?
What comes next? A long and boring summer with markets trading sideways? Or the long-awaited correction from a very long rally?
Professional traders were clearly taking no chances at the end of last week when they suddenly sold down their positions. At the very least some follow through from the retail investor can be expected on Monday.
The question then is whether we will see the normal buying on the dips and business as usual. The technical chartists are increasingly jittery but then they have been since the S&P 500 broke above its all-time high. The fundamental analysts still paint a mixed picture.
Falling US consumer spending last month, albeit only by a fifth of one per cent, does not square well with surveys showing high consumer confidence. Still upticks in US employment data and factory orders keep the bulls getting out of bed each morning.
Readers of ArabianMoney will know that we don’t really expect the bad news to upset this party to come from the United States. Japan, as the stock market gyrations last month confirm is the place to watch. We think its economy is perilously close to a bond market implosion (click here).
That would make Lehman’s failure look like a walk in the park. Japan is a very important global investor and if it is forced to dump its global assets to meet commitments at home the implications are enormous, albeit probably entirely overlooked by the largely domestically-focused US investor.
Trying to second guess the market implications, aside from the initial massive global financial crash are extremely difficult. Precious metals ought to be a major beneficiary, even if they are hit by the initial sell-off. They did such a collapse and bounce in 2008-9 and recovered far more quickly than any other asset class.
The problem is that we are talking serious damage to the real economy here. There would be actual wealth destruction on a large scale. Many participants would be ruined and never bounce back. That means a major blow to aggregate global economic demand and a depression in business activity.
This is actually the normal cycle of capitalism: assets are then acquired at cheaper prices and the economy gradually recovers. However, you do have very high unemployment and considerable poverty created in this process that can take many years to put right.
Staying fully invested in this climate looks like a recipie for losing a great deal of money. Cash is king in a recession and an emperor in a depression scenario, and the only true money is gold (and silver)! Our actionable investment ideas for this economic mayhem can only be read in our sister monthly investment newsletter (subscribe here).