Financial crisis Markets Fear 2008 Repeat

Before the 2008 financial crash, global stock markets carried on rising despite signs of a coming crisis. Today's situation bears an eerie similarity, many experts say.
Is the current share rally merely a calm before the storm?

The start of 2016 has seen turmoil on world stock exchanges, with rapid price falls and sharp but short-lived upward movements, before share prices plummet again. Germany's leading DAX index has lost 9 percent since the beginning of the year, and no major stock market has been spared.

Are we seeing the perfect storm brewing in the markets? Investor legend George Soros warned recently that current conditions remind him of the lead-up to the 2008 financial crisis. The 85-year-old American of Hungarian origin is no pessimist or doomsday prophet. Mr. Soros bet successfully on the devaluation of the British sterling in 1992 and he predicted heavy losses approaching in 2008 and again in 2011; and he was right each time.

Back then the collapse of the U.S. bank Lehman Brothers was the tipping point for the global financial crisis and a recession as had never been experienced in Germany. Gross domestic product went down 5 percent. The DAX lost 40 percent.

“Sell everything, except quality bonds,” Andrew Roberts of the Royal Bank of Scotland advised his clients last week.

Albert Edwards of the French institution Société Générale, referred to by some financial journalists as the über-bear for his proclivity for predicting the worst, forecast last week that the S&P would “fall to 550, a 75% decline from the recent 2,100 peak.”

The combination of lack of core belief and high equity positioning is dangerous and often leads to a sharp fall in stock market prices. Manfred Hübner, Managing director, Sentix

It's not the first time Mr. Edwards has warned of collapsing markets. His dire predictions should be viewed cautiously. But after the stock market upswing which began in 2009 and their collapse this year, there are six areas which demand caution. There are significant similarities with the horror of 2008.

Firstly the harbingers of doom which began to appear last year, announcing the end of the bull market. Typical precursor stocks and indexes started to turn negative, above all, the Dow Jones Transportation Index, which records the stocks of large transport companies. When freight loads on trucks, ships and rail start dropping off, it's a sign that customers are demanding fewer products. That points to a weaker economy. Professionals watch this index closely. It reached a high point in 2015. Since then, it has fallen by almost 30 percent. For example, the Transportation index had already started to drop off in early 1999 - a year before the market fell in the crash at the turn of the millennium.

Danger Signs-01

Because of the nature of their respective businesses, shares like the construction machinery giant Caterpillar, the aluminum refiner Alcoa and the auctioneers, Sotheby's, can act as early warning signals. Shares in all three have now been sinking for a year, just as they did before the crisis of 2008.

Bank shares are another indicator worth watching. Since the beginning of January shares in Deutsche Bank and Commerzbank have moved nearly 20 percent into the red. Most European bank stocks look the same. At the beginning of the crash in 2008, bank stocks took far more dramatic plunges than the stocks of large industrial groups. It took a long time for the crisis to reach BASF, Linde and Siemens, so that market players believed at first that the crisis would be limited to banking and real estate, and that the “real” economy would be safe.

Stagnating profits also act as a tell-tale. For a long time it's seemed as if Europe's weaknesses, China's slowing growth, and the crisis in Russia would pass German companies by. But, just as in 2008, stockholders have again ignored the warning signals. In total, the DAX has doubled in five years, to 12,000 points, but since 2010 profits of the top 30 DAX companies have been stagnant.

Share purchases on credit have been rising dangerously again. In boom times Americans buy large volumes of shares on credit. At the peak of credit buying in 2000 and 2007 around $400 billion of the stock market were financed on credit, according to financial data specialists Bloomberg. The result was the end of the boom. Credit-financed purchases in 2015 have exceeded even 2007 levels, reaching a record $470 billion.

The feeling that in these times of low interest rates there was no reasonable alternative but to invest in shares has carried the upwards trend in markets. On a weekly basis, Frankfurt financial analysts Sentix has been quizzing thousands of small investors and professionals about their investment preferences. Even in November their polling showed there were 35 percent more optimists than pessimists when it came to long-term share market prospects.

When European Central Bank chief Mario Draghi disappointed the markets in early December because he did not meet high expectations for a repeated flood of money, the number of pessimists multiplied.

Mr. Draghi said the central bank would extend its massive bond-buying, or quantitative easing, program until at least March 2017 – one year longer than planned. The bank said it would plow back the proceeds from bonds that mature into additional bond purchases. This left investors waiting for a pay-out disappointed.

Similarly, back in December 2007, pessimism was growing over long-term sustainability. A short time later, in early 2008, the stock markets crashed.

“The combination of lack of core belief and high equity positioning is dangerous and often leads to a sharp fall in stock market prices,” says Manfred Hübner, managing director of capital markets surveyor Sentix.

After almost seven years of rising stock prices, this has been one of the longest bull markets in history. But the world's most important stock market index, the US S&P 500, is now just jogging on the spot, just as it was at the end of the bull market in 2000 and 2007.

The late stock market guru André Kostolany would not have approved of such technical interpretation methods, but he would have drawn the same conclusions nonetheless. He expressed it as shares moving from strong to weak hands. That is, long-term investors sell to short-term investors who are lured by the boom. They often buy on credit. Kostolany also saw the accumulation of credit-financed purchases as a signal for a trend reversal.

Since the S&P 500 lost more than 10 percent, it truly looks like the markets have passed their peak. The upward trend has been broken, the downward trend is gathering pace. The falling 200-day moving average, that is, the trading average of the past 200 trading days, completes the bearish image.

There's no guarantee that this time it's going to finish up as it did in 2008. The markets just aren't that simple. Even if the parallels to the horror of 2008 continue after the recent losses, there is hope in the short term. The market is considered to be oversold and ripe for a counter-movement.

“After an initial plunge, the exchanges are likely to enter an approximately four-week stabilization phase,” predicts Sentix's Manfred Hübner. He doesn't expect more than a friendly intermezzo - rather, the opportunity for investors to sell at slightly higher rates.

“A second wave of selling will lead to panic in March,” he predicts. “There will be no real peace in the markets before August,” is his final tip.


Ulf Sommer reports for Handelsblatt on companies and financial markets. To contact the author: [email protected]