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Global Investing: Warning... Wall Street will crash again this autumn

Dubai - Similarities to the past are coming to fore, argues Matein Khalid

The american equities bull market is now seven years old and vulnerable to a rise in Federal Reserve interest rates that even Janet Yellen confirmed is probable this summer when she spoke at Harvard College. I cannot forget the S&P 500 index was 2,100 and the Volatility Index was 14 (almost near current levels) when the Yellen Fed hiked the rate for the first time since 2006. The result? A global financial firestorm. The S&P 500 index lost 10 per cent of its value in the next eight weeks. Crude oil tanked below $30. The US high-yield debt markets went into a free-fall. Wall Street money centre banks lost 15-20 per cent of their value, even though their net margins fatten when interest rates rise. The Chinese yuan sagged as Beijing battled epic capital flight and another crash in the Shanghai Shenzhen stock market.
Will another Fed rate hike spook the financial markets? Yes. The 25 per cent surge in the US dollar and the big chill in world trade (China) have exported deflation across the world, as King Dollar hits the pegged stock/property markets of the GCC and Hong Kong. The political omens have also darkened. Both Trump and Clinton have embraced protectionist rhetoric. From Ukraine to Spain, Berlin to Belarus, Warsaw to Vienna, Europe faces the threat of anti-EU, xenophobia, nationalist political parties, some a throwback to the fascisti of the 1930s. Brexit is a wild card that has divided both the UK and the Conservative Party, whatever the outcome. China faces the history's biggest credit Frankenstein. Boko Haram has wrecked havoc in West Africa. Venezuela is Latin America's latest failed state. Civil wars rage in Libya, Iraq, Syria, Yemen, Afghanistan and the Sinai. East Ukraine and the Crimea are under Russian military occupation. North Korea has tested international ballistic missiles. The Chinese Politburo routinely threatens both Taiwan and opponents of its maritime claim on the South China Sea. Does the US stock market reflect these risks? Absolutely not.
It is surely ominous that the Yellen Fed will be forced to tighten policy even though the macroeconomic data points to an unmistakable "profit recession" in both the US and Europe. Even the IMF concedes that the global business cycle is not immune to a fall in trade, cross-border capital flows and corporate profits. To paraphrase the Bard of Aron, a recession by any other name smells just as bad! There is no doubt that the world is on the precipice of the ugliest recession since the 2009 post-Lehman credit market Armageddon. Does the Volatility Index at 13-14 remotely price in another 2008 scale macro shock? Absolutely not.
I believe 2016 will witness a market crash on the scale of August-October 2011, when the S&P 500 index lost 20 per cent of its value. In fact, I would not be surprised to see American equities tank by 25-30 per cent since the outlook for earnings growth, margins, capex worldwide and geopolitics is so much uglier now than it was in 2011 and China, Trump, Russia, Venezuela, Nigeria, Daesh, Syria and the Sinai have raised the geopolitical risk barometer to crisis point. The foreign policy chickens of an impotent Obama White House will come home to roost on Wall Street this autumn and the world will fell the shock waves of multiple Lehman scale financial neutron bombs as Japan's Prime Minister Shinzo Abe so rightly predicted. So I go back in time to Black Monday (October 19, 1987) and Black Tuesday (October 29, 1929), savage stock market falls preceded recessions in 1982, 1990, 2008 and 2011. This time will be no different.
The Bernanke Fed's epic monetary experiment that bailed out the US and world banking system after 2008 also spawned speculative asset and credit bubbles that his successor's "QE exit" rate hikes will trigger. In July 2007, the peak of the credit bubble, US equities traded at 16.4 times earnings, far below the current 20.5 times. In July 2007, the 30-year US Treasury note yielded 5.1 per cent. In June 2016, the 30-year US Treasury note yields 2.2 per cent. This is overvaluation on a degree I cannot fathom or condone, no matter the LTV gobbledygook whispered to me by Private Bankerji! Lord Keynes said in the long run we are all dead. In the short run, we bleed with margin calls!
The writer is a global equities strategist and fund manager.