Macroscope | Wall Street’s crash in 1987 has an ominous parallel with today’s global markets
‘The disconnect between asset prices and macro-political and policymaking developments is indeed striking’
Thursday marks the 30th anniversary of “Black Monday”, the stock market crash on October 19, 1987 when US stocks plunged more than 20 per cent, their sharpest-ever one-day decline.
Not surprisingly, equity market bears are drawing parallels between the dramatic sell-off in 1987 and today’s frothy conditions in US stock markets which are enjoying their second-longest bull run ever and which are in bubble territory according to most valuation measures.
Richard Thaler, a University of Chicago professor who last week won the Nobel Prize for economics, echoed the views of many market commentators when he told Bloomberg TV: “We seem to be living in the riskiest moment of our lives and yet the stock market seems to be napping. I admit to not understanding it.”
The disconnect between asset prices and macro-political and policymaking developments is indeed striking. While there are numerous examples of market mis-pricing, the three most important ones are:
• US monetary policy: The Federal Reserve and the bond market are sending contradictory signals. While markets are currently assigning an 87 per cent probability to another interest rate hike in December, bond investors and Fed policymakers differ sharply when it comes to the outlook for monetary policy in 2018.
While the Fed anticipates three more rate hikes next year, futures prices are assigning a more than 50 per cent probability to rates remaining unchanged by June and an 8 per cent chance that they will be lowered by then. Even by September, the highest odds (nearly 40 per cent) are for just one 25 basis point hike.
As Datatrek Research, an economic consultancy, notes: “Why the split between Fed commentary and market pricing? One word: inflation.” Markets believe the Fed is far too optimistic on the path of inflation, increasing the risk of a major “policy mistake” if the Fed tightens (or is perceived to tighten) prematurely. Add to this the uncertainty surrounding both the prospects for US tax reform and the new leadership at the Fed once Chairwoman Janet Yellen’s term ends in February, and the discord between markets and the Fed could increase further.