October is a volatile month

October is the most volatile month in the stock market calendar.  The price of shares in world stock markets rise and fall like a yo yo in October compared to other months.  I don’t know why, but maybe October is when investors realise that their expectations of corporate profits are not going to be met by year-end and they react accordingly.  Anyway, the great stock market crash of 1929 which kicked off the Great Depression of the 1930s started in October. The huge crash in stock prices in 1987 was in October and the crash of October 2007 heralded the ensuing banking meltdown and the Great Recession of 2008-9.

But usually, any October ‘correction’ is followed by a rally from November  to Xmas, the so-called Santa Claus rally.  That’s what happened in 1987.  So what will happen this time?  Well, so far, stock markets have fallen from their peak by 10%.

S&P

The media is screaming, but a 10% fall is not really a crash.  On the other hand, there is a big difference between 1987 and 2014.

In 1987, the major economies were experiencing rising profitability in the corporate sector that began in 1982 and global investment and growth was accelerating.  In 2014, it’s different.  Global profitability is static and, as this blog has argued incessantly, global real GDP growth and investment is way below trend – an indicator of a Long Depression.  And the Eurozone and Japan are close to a new recession (see my posts,
https://thenextrecession.wordpress.com/2014/10/10/draghis-answer-to-euro-depression/and
https://thenextrecession.wordpress.com/2014/10/13/japan-the-failure-of-abenomics/
.
Indeed, profits for US top companies, shortly to be announced for the last quarter, are expected to show the weakest growth since 2009.

The world’s major central banks have been pumping credit into their economies by ‘printing’ money like there was no tomorrow.  Only last month Draghi at the ECB announced a new round of credit injections.  But these huge injections have turned out to be just more fictitious capital.  The money has ended up in the banking system and then been used to lend to banks, hedge funds, pension funds, asset managers and corporate treasurers at very low rates and they have speculated with the credit in stocks and bonds.  Thus there has been a huge rally since 2009 in the world’s stock markets and in government bonds, even of those governments with huge debts and no economic recovery like Greece, Portugal, Spain and Italy.

None of this credit has reached the so-called ‘real’ economy, or the productive sectors, for investment in new technology and skilled employment.  The money has been hoarded and speculated with. So stock and bond prices have increasingly got out of line with real economic growth based on value created by labour power globally, as this graph of Tobin’s Q, a measure of stock prices against the real stock of capital, shows (i.e. the blue line is well above average, if not as high as in 2000).

Tobin

This is unsustainable.  Indeed, unlike 1987, this is a bear market for stocks that began back in 2000 (see my post https://thenextrecession.wordpress.com/2014/02/07/waste-bear-markets-and-fictitious-capital/).  In that post, I pointed out that the huge boom in the stock markets in the last four years is way above even the substantial rise in the mass of profits in many major economies since the trough of 2009.  The return (in corporate earnings) against investing in the stock market rose to highs by late 2011.  But since then it has been falling back as stock prices rose much faster than earnings could keep up.

ROE

The graph was done before this October ‘correction’ so the blue line (the return on investing in stocks) has dropped back further.  But there is still plenty of room for further downside.

What has triggered this October crash is the fear among investors that economic growth and profitability is starting to drop and central banks’ injections of credit have stopped propping things up.  Indeed, the US Federal Reserve has an economy that is doing better (a bit) than others and ended its ‘quantitative easing’ this October and has been talking about hiking interest rates some time next year.  So the cheap money ‘gravy train’ appeared to be coming to an end.  This is the contradiction that I raised in another recent post (https://thenextrecession.wordpress.com/2014/08/01/the-risk-of-another-1937/).

Now it may be that this October stock market ‘correction’ will be reversed by a Santa Claus rally in November, especially if the Fed lets markets know that it will delay its planned rate hike and the ECB decides to extend its credit injections to ‘full’ QE by buying the bonds of distressed Eurozone governments like Italy, Spain or Greece.  But the Germans are vehemently opposed to such ECB bond purchases and the Fed is still looking at its overblown balance sheet and any sign of wage inflation in the US economy.  So neither the Fed nor the ECB may go for any more injections of fictitious capital, especially as they are not working to boost the economy.

The stock markets are rallying today as I write this.  It remains to be seen if this is just a short period of relief or the end of the ‘correction’ and investors recover their nerve and start a new round of bets with our money.

4 Responses to “October is a volatile month”

  1. Stavros hadjiyiannis Says:

    If the Fed sees that stocks are crashing and the US economy is weakening then we will probably get another round of QE. How do you see that the oversized balance sheet of the US Federal Reserve can prevent yet more QE? Now the effectiveness of any additional QE is anyone’s guess. As for the eurozone, I sense that the Germans will have to budge or risk having the eurozone completely shattered, something that will drag them deep into the abyss as well.

  2. Boffy Says:

    Michael,

    I agree with most of this, but.

    1) Your correct statement here that, “In 1987, the major economies were experiencing rising profitability in the corporate sector that began in 1982 and global investment and growth was accelerating”, seems to contradict the argument you’ve made in the past that the rate of profit did not rise during this period, and indeed your argument in your recent WW article that a period of Long Wave Winter began in 1997, that was prepared for by a preceding period of low and falling profits!

    2) You say, “Anyway, the great stock market crash of 1929 which kicked off the Great Depression of the 1930s started in October.” But, actually, it didn’t. As you stated correctly in a comment here recently, In Europe, the Long Wave boom, that began around 1890, ended around 1914-20. The depression in Europe had been running in Europe during the 1920’s. It did not start AFTER 1929. In fact, it was partly the bifurcation between Europe and the US, which continued to boom during the 1920’s, and whose currency expanded significantly under the Gold Standard, because of the extent of its exports to Europe, on the back of Fordism, that provided the excess of money-capital that went into the stock market speculation that led to the crash.

    3) The interesting thing to note is the degree to which the real bubble occurred in the 1980’s – the Dow increased 1,000% between 1982 and 2000. By comparison it has risen by only 70% since 2000. I’ve set out on my blog that this same pattern can be seen in other countries, and with other assets, such bonds, and property. In fact, stock markets often move up by larger percentages during periods of long-term economic weakness than they do during periods of growth. All of the money-printing over the last ten years, has only just about succeeded in preventing the bubbles from bursting. The reason for doing so much of it, has not been to save the economy, but to save the banks, whose balance sheets as you say are based on a mountain of fictitious capital.

    4) The appropriate comparison from the past with today is the Financial Crash of 1847, or maybe 1857. In both cases, as Marx and Engels describe, it was a period of growth, with rising masses and rates of profit, that caused low interest rates. Despite lots of productive investment in Lancashire mills etc. – similar to what we have seen in the development in China and elsewhere. Profits were so high that they could not all be invested, causing this money-capital to form a plethora, pushing interest rates down, which fuelled speculation, including in the Railway Mania. Engels describes how, businesses used their cash to engage in this speculation, and used cheap credit to then cover their business needs, which they also let “bleed”, because the capital gains from speculation were greater, and more immediate than the profit they could make from their businesses.

    The financial crisis came from effectively an accident plus bad legislation in the form of the 1844 Bank Act. The accident was the series of crop failures, which included the Irish Potato famine. It caused Britain to import large amounts of food causing a gold drain, which under the Bank Act, required a reduction in the currency, which led to a credit crunch, and a financial panic. The consequence of the financial crisis according to Marx was that it led to an economic crisis in which output fell by 37%. The 1857 crisis was similar in that it was a financial panic sparked by the 1844 Bank Act, which impacted the US first – crash of the Ohio Life Company. The initial cause there was the end of the Crimean War, which meant that the US no longer continued to ship large amounts of food to Europe, causing it to suffer a gold drain.

    But, in both cases, the financial panic was resolved by suspending the bank Act, and printing money. The crisis in both cases ended within a matter of months of the injection of liquidity. The difference between then and now, is that the state did not save the banks and others, and did not continue pumping liquidity into the system long after the credit crunch had been resolved. The effect was that the speculation was ended, instead of money-capital going to speculation, it went back to productive investment fuelling a continued boom that ran until the late 1860’s. As Marx points out, the crash in asset prices was cathartic. It transferred these cheaper assets into more dynamic hands.

    Last week I began writing an article on this basis, noting these contradictions in the economy. Andy Haldane in his article seems to have had simialr thoughts. Unlike Haldane, however, I don’t think these problems will be resolved by the bank trying to act like King Canute, and pretend it can determine interest rates. Global interest rates are rising, first in the emerging economies. But, as I wrote some weeks ago, that process will inevitably wash into the rest of the global economy. Already, that can be seen with the rise of Greek rates from around 5% to over 9%, and a sharp rise in Portuguese rates. Sooner or later that washes through into the other highly indebted countries like the UK and US too.

    As I write in the article referred to above, another 2008 is inevitable, because as interest rates inevitably rise, the bubbles in stocks, bonds and property, will burst – and its a 30 odd year bubble that has been inflated. Given that the global banks are actually insolvent, and only appear solvent because of the massive amount of fictitious capital their balance sheets consist of, that means the global banking system will be taken down with it.

    The reason interest rates will start to rise is simple. They fell in a secular trend after 1982, because the rate and mass of profit was rising so fast that it caused an excess of realised money-capital, over its demand, despite a rising demand for money-capital. Since around 2012, when the Long Wave Summer began, the rate of profit has started to fall. Companies and companies will continue to need to invest – possibly on an increased level due to crumbling infrastructure, and a need to produce new commodities to retain market share – but, the mass of realised money-capital will fall relatively (though continuing to rise absolutely, which is why companies continue to report rising earnings). The rise in the demand for money-capital relative to the supply, causes interest rates to rise.

    The money markets know that central banks cannot control interest rates. That myth is perpetuated by the state and the media because they want consumers and savers to beleive it so they will continue to spend, and buy over priced houses etc. But, when interest rates rise, asset prices fall, and given the massive bubbles, they will fall very, very hard.

  3. sartesian Says:

    ” Your correct statement here that, “In 1987, the major economies were experiencing rising profitability in the corporate sector that began in 1982 and global investment and growth was accelerating”
    ______________________

    Ummh……..no, not correct, at least for the US, a major economy. From 1982-1990, the actual profit per dollar of real gross value added in production for non-financial corporations (wow! that’s a mouthful), increased from 5.8 cents to 6.4 cents, a distinct deceleration from the the preceding 1974-1981 growth of 3.7 cents to 6.2 cents– so the increase in unit profitability basically unchanged in the 1980s.

    Growth, real growth in profitability takes place in the 1990s– from 91 to 1997 the unit increment crew from 6.4 cents to 10.6 cents.

    Overall growth of the mass of nonfinancial corporate profits were equally lackluster in the 80s– approximately 35% to 1990, well below the 110% growth in the 1974-1981 period, and the 130% growth of the 1991-1997 period. (All figures derived from the US BEAs NIPA tables).
    __________________

    “As you stated correctly in a comment here recently, In Europe, the Long Wave boom, that began around 1890, ended around 1914-20”
    ______________________

    Maybe Michael said that, but that doesn’t make it correct. There was a severe and fairly widespread contraction around 1895. So if we mark the “boom” from after the end of that contraction, and up to WW1, then we have…..a twenty year expanse– during which of course there were two cyclical contractions….so where’s the “long wave boom”? Twenty years is the “new” or old “long wave”?
    _________________________

    “The interesting thing to note is the degree to which the real bubble occurred in the 1980’s – the Dow increased 1,000% between 1982 and 2000. By comparison it has risen by only 70% since 2000. I’ve set out on my blog that this same pattern can be seen in other countries, and with other assets, such bonds, and property. In fact, stock markets often move up by larger percentages during periods of long-term economic weakness than they do during periods of growth.”
    _________________________________

    Gee, that’s really interesting– and it contradicts what Boffy claims in his earlier interesting analysis: that major economies were experiencing a rising profitability throughout the 1980s. So did the stock market do better in the 1980s because it was a period of economic weakness, or because there was rising profitability? It would be interesting to find out.
    _____________________

    “and only appear solvent because of the massive amount of fictitious capital their balance sheets consist of, ”
    ______________________

    What constitutes fictitious capital from REAL capital on a bank’s balance sheet? For example, are the holdings of Greek sovereign debt fictitious but the holdings of Portuguese or Irish or Spanish or Japanese or French sovereign debt real? Are the holdings of notes or other instruments of Siemens or Alstom real because Siemens or Alstom reports a profit in year 1, but fictitious in years 2,3,4 if and when losses are reported?

    Banks don’t have “fictitious” or “real” capital. They hold performing and non-performing assets; they have performing and non-performing loans on their books.

    Those “anti-bubblers” who argue that “fictitious capital” is the poison to real capital mimic from the other side, arguments of the structured investment vehicle salesmen, the managers of asset backed securities funds, of the quants etc. that “marking to market” will always minimize risk.
    _____________________

    “The reason interest rates will start to rise is simple. They fell in a secular trend after 1982, because the rate and mass of profit was rising so fast that it caused an excess of realised money-capital, over its demand, despite a rising demand for money-capital. ”
    __________________________________

    Absolute, total, gibberish. 1) the rate and mass of profit was not “rising so fast” 2) there was this minor event, this “blip” called the double dip recession 3) there was a slowing of rates of investment 4)there was the sustained attack on wages and living standards of the working class and a subsequent, and consequent, transfer of wealth up the social ladder.

    Brought to you as a public service.

  4. bruciebaby Says:

    Thx sartesian. I think you should have all of your replies to Boffy put in a book.

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