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Why the US stockmarket is rearing for a crash

"If America has a crash, the world has a crash."

Senior Digital Journalist, Your Money

When America’s stockmarket crashes, the world is almost certain to follow.

The question many analysts face today is not whether that will happen, but when.

Last year, veteran market analyst and former NSW Treasury adviser Percy Allan predicted America’s market would begin a downward spiral in 2019 – and take the world along with it.

While the Federal Reserve has responded to fears of a slowing US economy by keeping interest rates on hold, Allan told Trading Day it only delays the inevitable.

“The American market is still very overvalued. It’s had the longest bull market in history, every bull market ends in a crash,” he told Trading Day.

A bull market is characterised by many shares rising over an extended period of time, usually over a benchmark index such as the S&P 500.

America’s market has now run upward for more than 10 years following the GFC, making it the longest bull market since World War II and the longest ever in America’s history.

Analysts now fear that when major  indices begin to head south, global markets and economies are in for a hard landing.

According to Allan, there are two key signs that herald a crash and recession.

First, a spike in oil prices – which occurred late last year – and a negative “bond yield curve”.

Bond yields

Government bonds are considered one of the world’s safest securities and are used to provide some stability in the market.

Market analysts look to the yield curve as a benchmark for overall debt in the market along with economic wellbeing.

An inverse or negative yield curve refers to a situation where short-term bonds have higher yields than longer-term bonds.

This may be because when the economy is weakening, companies are more willing to hand out longer-term bonds that have lower returns to secure much-needed investment.

“Negative yield curves are remarkably reliable as predictors of recession,” Allan explained.

In December last year, concerns began brewing after the US yield curve inverted for the first time in 10 years.

“The typical pattern is you get a negative yield curve then you get a stock market crash and then you get a recession,” he said. “That pattern has repeated itself over and over again since the second World War.”

Inverse yield curves throughout history have proven a precursor to recession, as indicated by the grey horizontal lines.

 

Because the United States claims more than half of the value of shares globally, US bond yields are closely watched by analysts the world over.

“So, if the elephant in the room collapses, the rest of us are going to feel the impact,” Allan said.

Watch the full interview in the video above.

Read more: Does this chart show we’re headed for a recession?
More: ‘All bets are off’: Global market plunge continues
More: 5 ways the market will turn 2018 on its head

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