This month’s 6 per cent flash crash in the pound sterling and the soaring US dollar are ominous signs for global financial markets that increasingly look held together with sticky tape until the November 8 US presidential election is done.
October is traditionally a nervous time for global financial markets, and several historic crashes have occurred in this month. But global central banks and Wall Street are working overtime to keep the peace while the US election is in progress.
However, it is becoming increasing obvious to seasoned market observers that Brexit – the fateful referendum decision on June 23 by the UK to leave the European Union – was an unexpected “black swan” event for financial markets that is still playing out.
What was then the fifth, and now the sixth largest global economy, took what the IMF described as a “bad or very bad” decision to pull out of the largest trading bloc in the world and go it alone, without any coherent plan about how to achieve this revolution.
Incredibly such a monumental change was made by a simple majority vote. If one in 50 of those voting had voted the other way it would not have happened, nor if all British citizens living abroad had been allowed to vote. In any case no other democracy would have permitted such a change without a qualified majority vote or a general election.
This means extreme uncertainty while the Brexit is negotiated and that will take perhaps two years from the starting gate now set for next March. Hence the pound, which eight years ago was worth US$2, and over $1.50 just 12 months ago, is down at around $1.20. Gold is up 43 per cent in pounds this year.
Some UK finance directors expect $1 to a pound by the end of the year. Can the global financial system take this type of shock without it having major consequences elsewhere?
No, is the short answer. The US dollar is taking off as a safe haven. That makes American goods and services more expensive, one reason why the profits of large US companies have been falling for a year-and-a-half.
The profits of US multinationals from the European Union, the world’s largest economy that still includes the UK, are now less when sent home as US dollars. And yet stocks on Wall Street are trading at record highs, as are bond prices owing to artificially-manipulated low interest rates; and for that matter real estate, as its value is also interest rate-dependent.
What looks like a monumental asset bubble usually is a monumental asset bubble. It is just a matter of when it pops, not if.
Last December the Federal Reserve made a tiny increase in interest rates, the stock market sold off hard and gold prices soared by the most in three decades. Back then the Fed promised four interest rate rises in 2016, later revised to two, and as we now know nothing happened.
What if the Fed does finally decide to press down the interest rate plunger in December after the presidential election? Or could financial markets just fall over on their own if the pound sterling continues its relentless fall?
HSBC is not normally a name I associate with alarmist predictions but even Europe’s largest bank is warning of a “very high risk” of an imminent US stock market correction.
So how can readers prepare and even profit from such treacherous financial markets? The formula is simple: sell stock and bond-related investments and raise cash; buy precious metals; and take some short positions.
For the record, the world’s most successful investor, Warren Buffett, is sitting on a record $73 billion in cash.
The most sophisticated investors tend to buy themselves sell options to cover their open positions or just short the stock market indexes. But options are very risky if you don’t know what you are doing, so this is not advisable for the average person, and in market crashes even experts make mistakes.
All that said, the general level of confidence in global financial markets is running at its highest level since the 2008 crash. I suppose that is because the crash was a long time ago and central banks have successfully prevented another one since then, and therefore people conclude that it won’t happen.
Today’s much lower oil prices are already a canary in the coal mine singing about lower global demand, weaker trade and an imminent recession. Global asset prices are now way out of line with economic reality, held up by ruinously low interest rates that cannot last and the US political process.
Standing in front of a steamroller is never a good idea.
Peter Cooper has been a Dubai-based financial commentator for 20 years.
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