A man reads a copy of the Evening Standard on the day of the Black Monday stock market crash.
The S&P 500 stock index is on track to celebrate the longest bull market in its history next summer, but Bank of America Merrill Lynch’s chief investment strategist believes the era of low volatility and sky-high returns could end with a flash crash to rival that of 1987.
In a research note giving his overview of global investment strategy for next year, Michael Hartnett wrote: “The air in risk assets is getting thinner and thinner. Asset returns will likely peak in early 2018, but optimism fueled by recent stunning returns and historic low volatility could be followed by a sobering flash crash a la 1987, 1994 and 1998 as central banks, the major sedative of volatility, start to withdraw liquidity.”
In October 1987, large Asian and European stock market declines were followed by a 22% one-day plunge in the Dow Jones Industrial Average index in what became known as Black Monday.
Nearly seven years later, it was the global bond markets that suffered a sharp sell-off, while in 1998 world markets were rocked by fears of economic meltdown in Asia and Russia, which was forced to devalue its currency that summer.
Central banks, via post-financial crisis quantitative easing programmes, have been key providers of liquidity and drivers of market performance, but as they remove their stimulus, growth could slow to a crawl.
In October, the European Central Bank said it would halve the monthly amounts of government bonds it would buy next year in a downsizing of its stimulus policy, while in the US the Federal Reserve has begun to pare back its balance sheet in a reversal of its crisis-era stimulus programme.
Hartnett wrote: “The end of the Icarus trade – a central bank-enabled high-flying bull market with investors chasing growth and high yielding assets – could give way to an aggressive downgrade in risk assets once peaks in profits, policy and positioning become excessive.”
He added that there are already abundant signs of “bubble-like behaviour”, citing record art prices, soaring cryptocurrency valuations, as well as “exponential Nasdaq growth and US Treasuries, the first robot-managed ETF, climbing global debt levels and Argentina issuing a 100-year bond (the country has had eight debt defaults in past 200 years)”.
The Wall Street Journal yesterday reported fresh highs for bitcoin mania as the price of the digital currency surged by around 40% in 40 hours to beyond the $16,000 mark — it has since passed $17,000.
Meanwhile, the art world last month saw a record $450.3m paid for a Leonardo da Vinci portrait of Jesus Christ at auction house Christie’s, with the bidder identified as Saudi Arabia’s Crown Prince Mohammed bin Salman.