 Submitted By Greg Silberman
In late July we published a piece called 2007 crash market stock update wherein we described the inter-market picture as shaping up to be eerily similar to that of the 1987 stock market crash.
In summary: We noted that the stock market had been ignoring a falling bond market in much the same way as the stock market ignored a falling bond market back in 1987. We further explained that it was not until the Bond market broke below its May lows in September 1987 that all hell broke loose in the stock market and ended up in Black Monday, a one day drop of 22% in the S&P500.
We would like to revisit our hypothesis about a 2007 stock market crash as there have been two noteworthy developments.
Here are updated charts from the above article:
Chart 1 - 2007 crash market stock update (industrials above; bonds below)
Chart 2 - 1987 stock market crash (industrial above; bonds below)
The two items we are referring to both relate to divergences between the current situation and 1987.
Firstly – since mid July the stock market has been in correction mode. Whilst we think there is more to come – probably another 2 months to be exact – we note that this is a divergence in that the stock market only topped out in August 1987 not July as is the case now.
But probably more significant is the extent of the rally in US bonds today (bottom chart 1) as opposed to in 1987 (bottom chart 2). What caused the waterfall in stocks in 1987 was the fact that bonds broke below their May lows in September. The intervening bounce from the May low ended in Mid-June and was approximately 5% higher.
As of today bonds are around 5% higher than their mid-June lows but based on the flight to quality in the credit markets it doesn’t look like the rally is about to reverse any time soon and this will put a floor under stock prices. Although we do note that bonds are approaching stiff overhead resistance (chart 1 bottom - blue line).
As we said in the above article, history doesn’t repeat it merely rhymes. In which case the above minutia may not be significant to the big picture and we may still be on track for a 2007 stock market crash. But for that to become a reality we would need to see Bonds reverse lower and soon! In which case the market value of gold will benefit.
We’re certainly not out of the woods by any stretch of the imagination.
August 2, 2007
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