More Evidence of Boom Bust Cycles Driving Equity Market Prices

I have repeatedly been saying that inflationism or the boom bust cycle or my Machlup-Livermore paradigm, have signified as the key force in determining equity prices around the world (Philippines included).

The Financial Times observes of the same pattern taking hold in the US stock markets, (bold highlights mine)

The correlation between the movement of big US stocks is at the highest level since Black Monday in 1987, with price moves increasingly driven by the ebb and flow of investors’ fears over the economic environment.

Stocks, in theory, should move in individual directions based on company fundamentals. But markets of late have been characterised by mass selling alternating with waves of buying, as investors upgrade or downgrade the risk of the US slipping into recession, or a financial crisis sparked by a European sovereign default.

The correlation between the biggest 250 stocks in the S&P 500 over the past month has reached its highest since 1987 this week, at 81 per cent, according to JPMorgan figures.

This means those stocks move in the same direction 81 per cent of the time. The historical average is 30 per cent. The measure peaked at 88 per cent during the October 1987 US crash, when the Dow Jones Industrial Average fell 22 per cent in one session.

Other spikes in correlation, including the collapse of Lehman and the Japanese earthquake, peaked at about 70 per cent but quickly fell away.

The unusually high level of correlation this month has raised speculation that markets could repeat the aftermath in 1987, when relationships between stocks did not return to their historical norm until several months later, in March 1988.

With intensifying government intrusions in the marketplace everywhere, one should expect the financial markets to behave in tidal flows or in undulating motions with high or tight correlations, especially during steeply volatile days.

Yet such insights have not been covered within the ambit of conventional analysis, which is why most will find today’s environment bewildering.

Thinking out of the box is required to navigate today’s increasingly distorted marketplace.