What Could Cause a Market Crash?

07/03/2007 12:00 am EST

Focus:

Nicholas Vardy

Editor, Bull Market Alert, The Alpha Investor Letter, and The Global Guru

Nicholas Vardy, editor of the Global Guru, goes through the potential bubbles in the world today and speculates on what could lead to a systemic market collapse.

Markets crash when financial bubbles burst. Here are my own top three bubble candidates:

Bubble # 1: Global Property

Big bonuses on Wall Street and London, recycled petrodollars from the Middle East and Russia, combined with looser lending standards for the Average Joe, have driven property prices up across the globe. Property in central London is reaching dotcom-era levels of absurdity.

Bubble # 2: Private Equity Boom

Private equity today suffers from the familiar and often fatal symptoms of a financial bubble: "too much money chasing too few goods."  The fuel for this particular financial fire is low interest rates. Justified by plenty of "this time it's different" thinking, banks' looser lending standards may be planting the seeds of their own demise.

Bubble # 3: "Chindia"

The apparent inevitability of [China and India's]-"Chindia's"-domination in the 21st century mirrors predictions about Japan 20 years ago. Another worrisome sign of the Chindia bubble? Time magazine featured both India and China in cover stories over the past six months-a terrific contrary indicator.

The reason for the coming crash will be clear as day-with the benefit of 20/20 hindsight. Today, that reason is still murky. But here are some guesses.

Cause #1: A Sharp US Slowdown

A handful of economists predicts that the combination of skyrocketing debt as a percentage of GDP (gross domestic product), the slowest corporate earnings growth since 2002 and the collapse in the housing market will cause the global economy to fall out of bed.

Cause # 2: Rising Interest Rates

Change the interest-rate assumptions behind all those spreadsheet models that justify the investments by private equity firms, and the private equity financial locomotive can quickly become derailed. Every financial mania also has its iconic transaction that portends its collapse. Blackstone's [initial public offering]-and Steve Schwarzman's $9-billion fortune-just may turn out to be that transaction in the private equity era.

Cause #3: The End of the China Mania

When the China market crashes, it will be the most telegraphed crash in history. China's market collapse is not a question of if, but when. No market in the world-including the United States in the 19th century-emerged as a global economic power without massive booms and busts in financial markets. The only real question is whether global markets will have the stamina to shrug China's collapse off-or will China drag Western markets down with it.
The almost uncontrolled growth of credit, trade, and derivative flows makes this both a heady and uncertain time in global financial markets. But all this hand-wringing is perhaps the best news of all. Financial manias peak when the future is clear blue skies as far as the eye can see. Financial headlines about a coming crash may themselves be a contrary indicator. The mere talk of a crash provides a "wall of worry" for the markets to climb.

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