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World Cup: cue for a crash?

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by James Phillipps on May 21, 2014 at 15:00

World Cup years have typically been shockers for stock market investors, according to Lombard Street Research.

The 2014 crash?

Lombard Street Research analyst Dario Perkins says the World Cup is not just a time for football fans to be anxious. He points out that the first World Cup was in 1930, the full year of the Great Depression, and in recent times, disaster has continued to strike.

Events include the 1986 stock market crash, the 1990 US recession, 1994 bond market blow-up, the 2002 dotcom crash, the 2006 US housing crash and the 2010 eurozone wobble.

’OK, it’s not a perfect fit. The stock market crash came in 1987, even though the seeds were being sown in 1986, and the 2002 collapse started well before the World Cup kicked off. But the coincidences got me thinking. What could go wrong this time?

Here, Perkins outlines the potential causes of a 2014 crash

A bubble in financial markets?

‘Though equities and various housing markets don’t seem hugely overpriced based on conventional benchmarks, they are certainly not cheap either. Plus investors seem to be assuming a lot of things will go right over the next few years. Even if we believe structural forces, such as the glut of global saving, have pushed equilibrium asset prices higher, this implies relatively low returns to investors. If there are excess savings in the world, they should earn a lower average return, Perkins noted.’

‘Meanwhile, the aggressive policies of central banks may just have brought forward price gains from the future. If investors have missed this point and have been buying stocks in expectation of stronger cash flows and further capital gains, this is bubble-like behaviour and could end badly.’

Abenomics unravelling?

‘Abenomics is one of these potential bubbles. Aggressive monetary easing in Japan triggered a huge surge in the Nikkei and a collapse in the yen, in the expectation that the Japanese authorities could kill deflation and shift their economy onto a better medium-term growth path. But now these policies seem to be running out of steam and there is growing speculation of a rift between the Bank of Japan and the government. Kuroda has apparently become disillusioned with the government’s stalled reform efforts,’ Lombard Street Research's Perkins explained.

‘With the economy slowing in response to the April tax hike and the central bank apparently unwilling to ramp up QE again, there is a risk the Abenomics effect begins to unravel. This could push the yen significantly higher, which would force a number of global carry trades to unwind. I’m not saying this will happen, but here we are thinking about risks.’

A stalling US recovery

‘Even in the US, doubts linger about whether the economic recovery will gain traction. We think it will, but the housing market has shown a disturbingly large response to just a modest rise in mortgage rates over the past year. This is partly weather-related, but we won’t know for sure for another couple of months. If this latest recovery stalls, this would strengthen the hand of the structural stagnationists. It would also challenge the basic assumption of many investors,.’ Lombard Street Research noted

‘Over the past few years we might have expected the Fed to respond to such an outcome by stepping up its stimulus. But with the Federal Open Market Committee determined to end QE, partly in response to financial stability fears, the extra stimulus might not be forthcoming this time. We could be left with a stagnant economy and a feeling of vertigo in stock markets.’

A Chinese meltdown

‘Then, of course, there is China. We are assuming a persistent slowdown in China and a gradual intensification of financial sector pain, but after five years of credit-fuelled investment, the economy could unravel faster than we expect. House prices are already falling sharply in third- and fourth-tier cities and the economy as a whole is stuck with oodles of excess capacity, having ramped up output purely for the sake of meeting GDP targets.’

‘Moreover, the authorities are pursuing a wide range of financial and currency reforms, which could have a number of unintended consequences – both in China and for the rest of the world.’

The Russian situation

‘These are just the risks we can identify. There are others, the ‘unknown unknowns’. For instance, nobody really knows what will happen in Ukraine. We haven’t been writing about this because it is largely a political question and not something where we can reasonably hope to add value. But there are lots of potential outcomes and even those that fall short of World War 3 could have significant negative implications for global markets.

‘And this takes us into the realm of 'hyper risks'. The 2008 crisis should have taught us something about the complicated nature of global networks and the ambiguity of systemic risks. Like the England soccer team’s defence, the global financial system might be more fragile than we like to believe,’ Lombard Street Research concluded.

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