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Is A Major Stock Market Correction Imminent? A Historical Perspective

Mar. 06, 2019 4:17 AM ET
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Summary

  • Smart money has been cautiously bearish since 2016 - are they right?
  • Many analysts have been warning about an imminent 50% correction.
  • Historical perspective shows that equities could continue on an upward trajectory.

On the back of the longest bull market in history, the question on many investors' minds: is a major stock market correction imminent, or will the party continue? A historical perspective.

But it may well be that this time it really is different… For several years now, numerous high-profile commentators and analysts have been forecasting an imminent stock market correction, or indeed a crash, evoking the events of 1929, 1987, 2000 or 2008. Of course, many are now predicting it is sure to happen in 2019.

But so far, not many analysts – if any, apart from yours truly – have considered the possibility that this rally might extend even higher from today’s dizzying heights. In my March 2016 letter to investors, I suggested this may be what’s ahead of us.

Namely, I suggested that the (still) festering economic imbalances might get resolved along two alternative scenarios. Either we’ll have a full-blown deflationary depression that could see asset prices drop by 50% or more, or we’ll have a strong and sustained decline in the US Dollar. This second possibility could result in an accelerating and sustained commodity price inflation.

Historical precedents indicate that currency debasement could result in a continued rise in equity markets, as we saw most recently during the Zimbabwean and Venezuelan inflations, as well as the Argentinian, Brazilian, Israeli and German inflations before that. The following three charts showing the trajectory of Venezuelan, Israeli, and German equity markets at various times illustrate this dynamic at work:

Perhaps most interesting of all is the chart related to the German 1922 Weimar inflation:

Source: prof. Costantino Bresciani-Turroni, “The Economics of Inflation – A Study of Currency Depreciation in Post War Germany” – 1931.

What the Weimar inflation chart shows is that in spite of the nearly vertical rise in equity prices, this rise was eclipsed by the skyrocketing costs of living and the collapse of the currency. This “readjustment” effectively destroyed most of investor wealth.

Although most inflation episodes aren’t this drastic, inflation episodes should always be regarded as one of the very greatest risk factors for investors. Since 1960, more than two thirds of the world’s market economies suffered episodes of inflation that exceeded 25% in at least one year. On average, investors lost 53% of purchasing power during such episodes. In some cases losses of wealth were much greater.

To protect their wealth from the corrosive effects of inflation, investors should consider gaining exposure to commodity futures that have proven to offer the best protection against inflation, far outperforming equities, infation-linked bonds and even farmland investments.

The idea that we could experience an onset of such an extended period of inflation has been gaining attention as more and more inflation-related aggregates seem to be heating up. Timing the market decline could be difficult or impossible and I myself rely on trend following techniques to sail along with prevailing price trends and reverse course when and if appropriate. I've provided an explanation in the following 8-min presentation:

Alex Krainer has been actively trading commodities for over twenty years. He currently manages the commodities trading portfolio for London and Monaco based Altana Wealth Ltd., an independent $500 hedge fund firm. In the past he advised corporate clients on managing commodity price exposure risk. In 2015 he published the book “Mastering Uncertainty in Commodities Trading“. Among the few readers who posted a review, most gave it a 5-star review.

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