Friday, April 11, 2014

Faber Warns of Stock Crash

File:Depression-stock-market-crash-1929.jpg
Crowds On Wall Street Following 1929 Crash

The man who predicted the 1987 stock market crash and the recent global economic recession believes the worst crash in decades will take place later in the next 12 months.
Dr Marc Faber, a Swiss investor and the author of the Gloom, Boom & Doom Report, said the cause of the crash would be overvaluing of companies within the internet and biotechnology sectors – thought to include the $400billion valuation of Google, and the $100billion valuation of Facebook.
 
He also said the market was also beginning to wake up to the idea that the U.S. Federal Reserve is a ‘clueless organisation’ – something he says is starting to affect confidence levels in investors.

Speaking to CNBC last night, Dr Faber said: ‘I think it's very likely that we're seeing, in the next 12 months, an '87-type of crash’… and I suspect It will be even worse.’
 
His comments came as the Nasdaq suffered its biggest drop in two-and-a-half years after another sharp selloff in biotechnology businesses - including Gilead Sciences and TripAdvisor.
Faber has been warning about his for several months, so this is not just a prediction prompted by the Nasdaq losses over the last few days.

The 1987 stock market crash saw the largest single day decline (on a percentage basis) in the Dow Jones Industrials (22.6%). Other stock markets also saw precipitous declines in value--some over 50%. (Source). Although various causes have been advanced for the crash, none appear to fully explain what happened. The favored theory seems to be that automated trading magnified what otherwise would have been a more modest drop. (For an interesting read, see this Fortune article on the causes that was published only a month after the crash).

After the 1987 crash, the SEC implemented several reforms, including a "circuit breaker" to cut out trading programs in the event of a steep decline. However, one has to wonder how effective some of those reforms--which were focused at the actual formal markets--would work now. As this Reuters article from a few days ago discusses:
Fears that high-speed traders have been rigging the U.S. stock market went mainstream last week thanks to allegations in a book by financial author Michael Lewis, but there may be a more serious threat to investors: the increasing amount of trading that happens outside of exchanges. 
Some former regulators and academics say so much trading is now happening away from exchanges that publicly quoted prices for stocks on exchanges may no longer properly reflect where the market is. And this problem could cost investors far more money than any shenanigans related to high frequency trading. 
When the average investor, or even a big portfolio manager, tries to buy or sell shares now, the trade is often matched up with another order by a dealer in a so-called "dark pool," or another alternative to exchanges. 
Those whose trade never makes it to an exchange can benefit as the broker avoids paying an exchange trading fee, taking cost out of the process. Investors with large orders can also more easily disguise what they are doing, reducing the danger that others will hear what they are doing and take advantage of them. 
But the rise of "off-exchange trading" is terrible for the broader market because it reduces price transparency a lot, critics of the system say. The problem is these venues price their transactions off of the published prices on the exchanges - and if those prices lack integrity then "dark pool" pricing will itself be skewed. 
Around 40 percent of all U.S. stock trades, including almost all orders from "mom and pop" investors, now happen "off exchange," up from around 16 percent six years ago.
The SEC is looking at proposals to limit "dark pools."

It may also be relevant that JP Morgan/Chase, which allocated its capital to trading (rather than lending), saw a 19% decline in profits, while Wells Fargo, which does little trading, but has been lending, saw profits rise 14%.

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