Stock market theorists like to compare share price formation with pitch-and-toss: each time a coin is tossed up, the chances of winning or losing are equal, no matter how often heads come up first. This is mathematically indisputable, even though intuition would tell us otherwise.
Market participants, however, dismiss the random-walk-theory. They like to compare their price expectations with a jar filled with white and black balls: each time you reach into the container to retrieve a white ball the odds are growing to eventually pull a black one.
Markets, the worldwide endeavour of selling and buying stuff, is a human affair. Even advanced machine intelligence fails to calculate a prognostic equation with so infinitesimally numerous unknowns.
We do not know whether market movements are anything but random, if there is a demonstrable pattern buried in such collective human behaviour, or not. Yet we observe a perpetual cycle of boom and bust with its turning points easy to rationalise – retrospectively. We hear that the “longest bull run in history” had come to an end as it had to; worldwide debt levels had been at historical highs; the “yield curve was flattening”, signalling trouble ahead, or stock valuations were overstretched.
Such explanations are not pulled out of a hat. They are valid, each by itself. It will be circumstances like these that trigger a market crash. The end of ‘quantitative easing’ – the liquidity deluge provided by the world’s central banks to soften the last, massive recession; the rise in oil prices; the drop in oil prices; the rise in interest rates, or the fall of it; the irresponsible actions of ‘tariff man’; the rise of the left, or the rise of the right; China’s stalling; emerging market dithering.
There is trigger potential in all such events. Alas, we will never know for sure what the last straw was which broke the camel’s back. A crash happens when people crowd at the exit gate. Why they do it at precisely that moment is difficult to grasp and even more difficult to predict.
Institutional investors and we retail investors alike watch each other with trepidation, trying to second-guess when the stampede will start. It is like passengers boarding a plane. People idle in their seats, waiting for the gates to open. Until someone starts to queue. And another one. And then the many. Although strictly speaking there was no valid reason to do so at all. Each could have stayed in their seat until the boarding announcement.
The nagging fear to miss out on some nebulous advantage made all passengers behave irrationally, inflicting collective discomfort and harm to all. This is where random walk and rationality meet. People have to go to the gate if they wish to catch the plane. Yet when they decide to do so is up to them and entirely accidental.
The other observation that can be made is that while each segment of a market carries unique, independent risk momentums, they are nevertheless mutually amplifying. The chaos of Brexit is completely unrelated to the EU-Italy budget stand-off. The anarchic ‘yellow vests’ threatening the rule of law in France are acting independently from immigrant-bashing AfD marchers in Germany.
Khashoggi’s murder by order of the Saudi Crown Prince, and special investigator Robert Mueller closing in on Donald Trump, take place in different universes. Yet a sense of too many things going awry add to the nervousness of investors. They get twitchy and stare at each other, ready to make a dash for the turnstiles as soon as they see groups gathering near the gate. It does not matter that professionals see no reason to act now and then. Panic, augmented by behavioural algorithms, will eventually force their hand too.
Stock markets ended 2018 lower than they had started off. Many of them are deep in negative territory, like European banks, China, the retail sector. Not even techs, seemingly the best bet in 2018, could defy gravity. Volatility is growing, and bond prices are on the rise again just when we thought that quantitative easing is over and yields will rise now steadily.
I see no crash coming, but the stock markets listlessly and inexorably deflating, with bouts of optimism followed by further retreats
For a while we followed professional advice to ‘buy the dips’, adding positions when share prices dropped. Yet increasingly we are less convinced of doing the right thing. The queues at the gate get longer. The plane is possibly overbooked. Not only could we face difficulties finding space for our hand luggage in the overhead lockers, latecomers might be refused boarding altogether.
Investors, fearful like rabbits facing the headlights, look at the Chinese economy, where growth is still enviable, if clearly smaller than in the past. US growth, fuelled by cheap money, exceptionally low unemployment and pro-cyclical tax reductions for corporations and the wealthy, is still impressive – yet a tad slower than expected, with US inflation seemingly in retreat again.
All in all, economic activity seems to hum along nicely. Is it not absurd to worry when unemployment is at historical lows and profits are still rising? Yet nagging doubts are palpable. The bull run of the last 10 years was never really trusted. It feels right to bury it now for good.
As I have pointed out above, a downturn will not so much be caused by empirically demonstrable factors but by a contagious change of sentiment. The trigger moments for such mood changes are difficult to pin down. Why is Italy’s indebtedness of 130 per cent GDP worse than Japan’s, which stands at 240 per cent and counting? Why is China’s growth rate at 6.5 per cent alarmingly low, when Germany’s growth was celebrated at 2.4 per cent? What ever happened to Greece?
Why is no one talking about North Korea anymore, but increasingly worried about geopolitical tensions between the US and China? In retrospect, every crash can be explained rationally. There were reasons. In real time we only worry about what we see at the moment, to quickly forget when something else grabs our attention. We may ignore a flashing red with equanimity, and panic over trifles. Any forecast is as scientific as a horoscope.
Therefore, in this, my last column of 2018, I will try to express my fears and hopes for 2019, rather than dabbling in any dubious attempts of forecasting.
Italy and the EU will proceed amicably. Spain will painfully remind us that Podemos and Syriza in Greece were quite agreeable after all. France will briefly look more governable, at least for a few months, a state of affairs only hoped for in Germany during Angela Merkel’s end time.
Trump’s trade war with China, and the rest of the world for that matter, will not come to much, with a fig leaf ‘deal’ papering over an increasingly serious strategic rivalry. Russia will be hit hard by yet another damaging embargo assault – the only thing on which Democrats and Republicans can happily agree. The Russian banking system will struggle or refuse to make dollar payments for its account holders. If there’s an opportunity to innocently default, Russia will jump on it.
Brexit, so deeply dividing the British electorate and cutting precisely through the middle of both Labour and Tories, will not be politically decided, but by default. The government will ask the EU for more time, or will try to withdraw its divorce note. Five minutes past midnight Theresa May’s Brexit agreement will look acceptable to most MPs. Chaos in the weeks to come will be billed a ‘buying opportunity’ by Brexiters.
The oil price will not be supply-controlled anymore, and wither. A sudden spike upwards will only be triggered when Europe’s attempts to keep the Iran accord alive will finally come to nought. Yet it will be a flash in the pan. Neither the Gulf, nor Big Oil, nor China will look investable. Nor other emerging markets. Nor anything else.
I see no crash coming, but the stock markets listlessly and inexorably deflating, with bouts of optimism followed by further retreats. Meagre bond yields will increasingly look good enough. Index investing, exchange-traded funds will be out of favour as only few stocks will shine. The reason why they do so will be ever more haphazard. In short, 2019 will have too many black balls in that jar. Perhaps I am wrong. Perhaps the flight will be cancelled and we have a glass together in the departure lounge. Happy New Year.
Andreas Weitzer is an independent journalist based in Malta. He reports on the economy, politics and finance. The purpose of his column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice or advice on the buying and selling of financial products.
andreas.weitzer@timesofmalta.com