Monthly Discussion

Is There Going to Be a

Stock-Market Crash?

This question has never ceased to be relevant. If the market takes a dive, the question is triggered by the ominous reminiscence of a crash, and if the market skyrockets, by the very fact. I feel compelled to point out here something I have learned in a University course on logic: whenever one can use a thesis and its antithesis to argue a point, one can equally well use the same thesis and its antithesis to argue the opposite point! Expectedly we are witnessing crash proponents and crash opponents all the time.

The market has both skyrocketed and dived recently. Interestingly the crash proponents/opponents have been rather segregated. It is years now that academic literature covets an inevitable crash while traders’ prose heralds an endless boom. One may suspect (not without reason) that popular books such as Bent’s The Coming Boom have poured oil over the flame of the stock-market craze, whereas television appearances of distinguished professors, and articles in the respected The Economist, have triggered market dives with their ominous messages. The latter carry more responsibility than the former due to the nature of the stock market (sensitivity to panic) and the tragic drama entailed in a major crash.

I partake in both groups but have allegiance to neither. Still, I carry luggage from my experimental-physicist days when the first thing we did with a newly bought apparatus officially calibrated to put out something was to re-calibrate the apparatus ourselves making sure that it puts out what it is supposed to put out.

The case at point is a graph, published in The Economist on September 25, 1999, reproduced below in Exhibit 3. The graph highlights the evolution of stock prices in the US and Japan during the nine years that preceded a great crash. Normalized to the same level at the beginning of the 9-year period the evolution of stock prices in the period 1991-1999 seems to trace an identical fate. The obvious conclusion is that a manifold decline is to follow in the next three years.

Exhibit 3. “The mirror of history”. Share prices rising and leading into a crash, as reported in The Economist on September 25, 1999, (data points every trimester). The open circles represent recent data.

Considering that The Economist only had data up to the end of the second quarter of 1999, the first thing to do is to add four more quarters on the same graph. These data points are shown in open circles in Exhibit 3 and go considerably toward proving that a crash did not take place as advertised.

But then, maybe The Economist was off by a few quarters and the crash is around the corner only now. To check this hypothesis we must displace the yellow line to the left by four quarters and renormalize it to a year later. This was done and is shown in Exhibit 4. The exercise diminishes the similarity in stock-price evolution between recent years and the years preceding the major US and Japanese crashes.

Exhibit 4. A variant of Exhibit 3 with the yellow line renormalized to a year later and displaced to the left by one year. A stock-market crash seems less warranted today than in mid 1999.

Was The Economist wrong to ring the bell last September? Should it be held responsible (at least in part) for this year’s market turbulence?

One thing is true: the Economist article was timely (true to the magazine’s reputation!) With all the data I my disposal, I was able to slide the yellow line, one quarter at a time, back and forth, examining the similarity with the other two pre-crash periods. I obtained less and less ominous pictures the more I moved away from the situation depicted in Exhibit 3. The similarity peaked in mid-1999 and that’s when The Economist blew the whistle. Whether they became instrumental in letting air out of the bubble, is another story. The new moral is that a crash is now less “around the corner,” just as it should be!

There should be no crash ahead of us according to the Kondratieff economic cycle. I became a cycle believer only for what concerns this 56-year cycle, evidenced in glorious detail in my book Predictions. This cycle ticks like a clock and times, among other things, world economy and stock-market crashes. There was a crash in 1873 in Vienna (world economy was centered in Europe at the time), there was another one 56 years later in New York (1929), and another lesser one 58 years later (1987). According to this clock another crash is not due for another 40 years or so.

Granted the clock is not very accurate. It was 2% off in 1987, which made me lose instead of make money then (I knew about the clock I just ignored its accuracy.) But the clock is accurate enough to reassure today’s investors.

I wish more of them would read this letter, so that I become even more confident about this prediction!