Professional Investor: Will there be a crash? Yes. When? Er, um...

Click to follow

Back in October 1987, the storm that hit South-east England acted as the perfect analogous prologue to what was about to hit the stock markets the following trading day.

The monumental drop on the Dow Jones Index reverberated around the globe as it plunged 508 points, or 22.6 per cent, on what was then record volume. The day became known as Black Monday. How appropriate then that we should be concerned about this anniversary as the Dow has again been reaching record highs.

That single day's collapse in value has never since been beaten. The Great Crash of 1929 may have been deeper and longer, but it never had such single-day plunges. However, that damage was far longer-lasting and real value was not achieved again until the mid-1950s.

Compare that to the switchback ride in 1987, when the Dow had recovered half of its losses by the end of the year, and by December of the following year it was nearly 25 per cent higher.

There was, in fact, one greater percentage drop – of 24.39 per cent – on 12 December 1914, but that was somewhat distorted owing to the closure of the market at the outbreak of the First World War.

So can the same thing happen again? And is it about to happen now? First, both economically and politically, the world is a very different place, with globalisation having opened up closed economies in a way thought unimaginable back then. Russia, India and China now have a significant impact on world trade and investment.

This means that investment markets have been spread around the world and are far less concentrated on the leading US indices. That's not to say that there can't be contagion between them, but there is at least some separation.

Second, we should consider valuations. The US market may be reaching record highs, but the trailing price/earnings ratio on the S&P 500 index stood at 22 in 1987, compared to a lower figure of 18 today.

Also, the bond market back then was in the depths of a bear market, with 30-year yields at 10 per cent compared to a mere 4.87 per cent currently.

Third, after the 1987 crash, the NYSE implemented some control measures by way of circuit breakers to prevent overheated markets getting out of hand. To date, they have yet to be enforced.

Finally, there is, in my view, one key area of difference. Both in the UK and US, the investing attitude among the prevailing "yuppies" of 1987 was one of infallibility. The market was rising and we were the kings of capitalism, worshipping the idols of the stock exchanges. What could go wrong?

Today, many market participants are spooked by fears of impending catastrophe (some of which have already come true with the sub-prime debacle), and in some sense there has been an expectation that something will occur over the next few months. If this is still a bull market, it is one with a nervous tic.

There are still some worrying issues that the sentient investor should be quite rightly concerned about. Inflationary pressures, both domestically and imported from China, are going to be an increasing concern, along with the ability to cut rates in the face of weakening economies.

Pressure on the consumer, both from rising costs and a fracturing housing market, will dent confidence and thus the opportunity for further growth.

The geopolitical threats that are ever-present can also surface into peaks of worry at key moments. Currently, the concern over Turkish-US relations and the threat of incursions into Iraq have pushed crude oil prices to record levels – never a good sign for global growth and confidence.

However, maybe it is the concern over increased protectionism by Western nations, in terms both of trade and of inward investment by cash-rich nations such as Russia and China, that could take us to a higher level of alert as nations seek to defend assets from Johnny Foreigner. Funny; I thought that was what we have done to them for decades.

So will there be another crash? Yes – but who knows when. Timing the market is impossible, but adjusting for risk is always vital – and yes, these are riskier times.

Justin Urquhart-Stewart is a director of Seven Investment Management

Looking for credit card or current account deals? Search here

Comments