1 April 2020
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What are the intelligent lessons from this stock market craziness?

Peter Switzer
7 February 2018

It’s been a dramatic week for material comfort, with many wondering if we were looking at the kind of stock market crash that generally brings a recession, job losses, terrible super returns and a hell of a lot of dream crushing for individuals and businesses.

So, what have been the lessons from the biggest point drop in history, losing 1175 points on Monday, wiping out all the 2018 gains? Before the close of trading on Wall Street, all the market indexes were back in positive territory but the experience can’t be ignored.

But at it’s worst, the Dow was down an incredible 1600 points, which didn’t underline the economic and company profits threats but warned that crazy, computerized trading has become a huge concern for volatility.

Some experts are warning regulators that exotic exchange traded products linked to the VIX or “the fear index” is behind these excessive moves on stock market indexes.

The GFC came about because regulators ignored the potential threat of the sub-prime lending in housing to people who, in the old days, would never have got a loan. And then there were collateralized debt obligations (CDOs), which were pooled assets – such as mortgages, bonds and loans. These are essentially debt obligations that serve as collateral for the CDO product that financial institutions bought and sold. As investopedia reminds us, “the tranches in a CDO vary substantially in their risk profile” and the once highly respected debt-ratings agencies completely rated these CDOs incorrectly. This spooked the financial system, creating what we called the GFC or global financial crisis.

This brought a 50% crash in our stock market and while most economies went into a “Great Recession”, as the Yanks called it, with surging unemployment, we dodged that bullet. We can’t expect that we’ll do that again.

So here are the big lessons of this week:

• The US stock market is in the euphoric zone and this is where bull markets die. And while our market is pre-euphoric, we will rise and fall with Wall Street.

Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management, gave a wise observation of the week to CNBC: “I think this bull market is basically in the process of forming a top,” he said.  “This is the first crack of it.” Once we hit the top of a bull market, the next phase is a bear market.

• We will see huge volatility over the next couple of years and many smarties think 2020 will bring the next recession. So the stock market could get very worried in 2019 some time.

• Regulators need to look at what created the crazy computer-linked trading on Monday morning, US time.

So that’s the bad news but there is good news and it comes from research from Citi and reduces our fears about a bear market lurking around the corner. “Good news is our checklist shows that only 3.5/18 factors are flashing SELL compared to 17.5/15 in 2000 [the dotcom crash] and 13/18 in 2007 [the GFC crash].” Citi strategists said. “So our bear market checklist says it is too early to call the end of this bull market.”

The Citi team warnings imply we will see volatility and drama on stock markets over the next couple of years. So what will determine the life of this bull market?

It’s going to be a battle between how fast the Fed raises interest rates, which will be determined by the economic story versus the strength of company profits.

For me, I’m comfortable being long stocks until some time in 2019. Then I could get super cautious but I hope regulators look at the computer-linked trading that added to the market madness this week.

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