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Is The Stock Market Gearing Up For A New October Crash?

We have been studying the behavior of the financial markets in the past few months and quarters was we are convinced that not only is the economy running out of steam, there might be another overdue correction.

What really frightened us is the fact there are several similarities and correlations with the previous market crashes in 1929 and 2008. Let’s start with 1929 and pull up a first chart. You can clearly notice there was a brief stock market slide which was converted in a temporary uptrend before the entire index was completely crashing.

Source: Wikipedia

This seems to show an awful lot of similarities with the situation we’re currently in:

Source: stockcharts.com

Just as in 1929, the market was performing fantastic and the continuous wealth increase seemed to be unstoppable. A short 10% correction was seen as ‘healthy’ and soon a new uptrend was starting (the green line). This is exactly the same scenario we saw in the past few weeks. Market commenters said the 10% drop in the Dow Jones was a ‘healthy correction’ and we’re on our way to the next uptrend and Christmas rally.

Are we?

Let’s have a look at why the stock market crashed in 1929. First of all, the harvests were higher than expected, pushing farming families into poverty. Additionally, the house sales, car sales and steel production were falling back down to earth in the USA. Is this once again the case in the US? Not really, but keep in mind this is a globalized world and you’ll have to look at the global picture. So let’s expand our horizon and focus on for instance China, which undoubtedly is one of the main (if not, the main) economic forces on this world.

Source: RBC

There’s no real crash in the steel production but that’s usually an ‘ex post facto’; the real drop in the steel production numbers usually occurs àfter the second leg down has started. In that view, the stagnating steel production in conjunction with a reduced demand for iron ore is already an important sign the steel mills aren’t too optimistic about the future and want to reduce their existing stockpiles before taking on too much balance sheet risk.

Source: RBC

Have a look at the previous image. The stockpiles of iron ore are crashing in China, the largest steel producer in the world. If the Chinese steel mills would indeed be convinced the demand would remain strong, why on earth wouldn’t they be stockpiling a lot of iron ore, considering the iron ore price has reached a multi-year low?

You can think about the Chinese whatever you want, but they are very business-savvy and have an excellent feeling for timing. If they don’t want to buy iron ore at low prices, you can be sure they aren’t very optimistic about the future steel production.

Another dangerous parallel with the 1929 crash is the amount of margin buying deployed in the market. This was an important trigger in 1929 as margin calls pushed the share prices deeper and deeper. In fact, the situation is even worse today. Have a look at the next chart which represents the Margin Debt on the New York Stock Exchange.

Source: advisorperspectives.com

Right now, the total amount of margin debt on the NYSE is higher than right before the 2008 crash and the bubble in 2000. It sure looks like nobody has learned anything from the past. The higher the amount of margin debt deployed in the stock market, the faster any collapse would accelerate.

And oh yes, before we forget, it’s October again.

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