Four Potential Elements Could Burst the Current Stock Market Bubble
Investors are showing some welcome signs of realism. The Dow Jones has stopped its relentless climb toward the next major target, 20,500 points.
It seems that the Federal Reserve’s historic decision to switch from quantitative easing (QE) to quantitative tightening (QT) has prompted some people on Wall Street to think a little harder about their next stock purchase. Indeed, it seems that investors are suddenly starting to remember that no economist has come up with a pill to prevent a stock market crash.
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The world has seen nine years of the world’s central banks, led by the example of the Federal Reserve, influencing the markets. The Fed, by keeping interest rates near zero, has influenced the Dow’s performance in the same way that anabolic steroids influenced the performance of a certain cyclist who won the Tour de France several consecutive times in recent decades. That cyclist’s records were stripped, but the Dow’s record still stands.
Perhaps, sooner or later, there will be a stock market crash. That’s because the market is experiencing a bubble.
Market bubbles tend to have three elements in common:
1. A new and revolutionary technology, which promises great returns in the future, while offering unclear value in the short term. We saw this with the dotcom bubble. We’re seeing it now, with its 21st century equivalent in the tech sector. See, for example, the valuations of Tesla Inc (NASDAQ:TSLA) that are still in a bullish phase. Or, consider the valuation of the darling of March 2017, Snap Inc (NYSE:SNAP), which is trading at less than half of its initial public offering (IPO) close.
2. More importantly, a bubble needs cheap money, and lots of it. This is what is meant by easy liquidity, and there certainly has been much of that lately.
3. The third element, the tap from which stems the easy liquidity is key. The end of cheap credit is the pin that will burst the bubble.
(Source: “The warnings from history that Wall Street ignored,” The Financial Times, August 6, 2017.)
There’s a fourth potential pin to burst the bubble: it’s called North Korea, and investors have been slow to catch on to the magnitude of this threat.
North Korean Threat Gets Serious
Apart from the Fed’s warning (or promise, depending on your perspective) to start drying up liquidity, investors have suddenly noticed there’s a country called North Korea. Its leader, Kim Jong-un, wants to ensure his regime’s survival at any cost. To do so, he is willing to defy the certainty of heavy economic and diplomatic sanctions. Indeed, Kim Jong-un seems ready to defy President Donald Trump’s repeated warnings.
It has been an especially tense couple of weeks as the United States and North Korea have traded threats and insults. Fueling the fire, North Korea’s ministers at the UN General Assembly in New York warned that it’s ready to detonate the most potent hydrogen bomb test in the Pacific soon.
While politicians ponder whether Kim Jong-un is bluffing, there are good reasons to believe him. The Korean government has successfully launched missiles capable of carrying a nuclear warhead past Japan, and potentially able to hit U.S. interests. Japan is a North Atlantic Treaty Organization (NATO) ally. Guam, a U.S. territory, is within range of North Korea.
Investors should take Kim Jong-un’s warning even more seriously. Should North Korea proceed with a nuclear bomb test, the effects of the mushroom cloud will not spare stock valuations on Wall Street. Apart from how Trump might react, Japan and South Korea—two major cogs in the global economy—will rightly feel threatened.
Trump, meanwhile, has hinted that he would seek the “total destruction” of North Korea should it go on the attack. But even Trump’s closest advisors will inform him that wiping North Korea from the map won’t benefit anyone. For the time being, Trump has limited his response to piling on more sanctions against North Korea. The problem is that Kim Jong-un feeds off of international conflict and sanctions. They make him ever more defiant. Certainly, so far they have not stopped him from developing the technology to make rockets and enrich uranium at a military grade.
The U.S. government will consider any new missile or bellicose statements from North Korea as serious. The more that Kim Jong-un pushes his game, the more imminent the danger of war. Whereas a war in the Middle East can drive the markets higher (as happened in 2003), a war against a would-be nuclear power will force investors to ponder the very survival of the human race, rather than the state of their financial portfolios. Sentiment could become extremely bearish.
On a more practical note, even if the market survives a nuclear exchange between Washington and Pyongyang, China would react badly. It does not want the U.S. interfering in its sphere of influence. Russia, which has gotten ever closer to China, will not come to Washington’s aid.
As someone once said, if you break it, you buy it. Smashing the North Korean regime would burden the Americans with a problem they don’t want and don’t need. That’s why North Korea cannot be ignored as a threat to the markets—apart from everything else, of course.
