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NAFTA's demise just one potential trigger for a market crash: Don Pittis

The failure of NAFTA would be just one possible nudge toward a market tumble as experts seek parallels to the crashes of 1929 and 1987.

Business pages are humming with comparisons to 1929 and 1987's Black Monday market declines

A piece of tickertape showing stock prices from the Great Crash of Oct. 29, 1929. As markets continue to rise, business pages are filled with comparisons to the past. (Lucas Jackson/Reuters)

As stock markets have continued their relentless rise, investors watch fearfully for something that could trigger a rush for the exits.

Although the date fell on a Thursday this year, yesterday was the 30th anniversary of 1987's Black Monday, when markets plunged about 23 per cent in a single session. The equivalent today would be a drop in the Dow Jones Industrial Average of more than 5,000 points.

No one knows if or when another market crash might come, but as business commentators glance warily at the inflated value of assets, there has been plenty of speculation about what might be the one little nudge that could cause nervous traders to lose faith.

Canadian Foreign Affairs Minister Chrystia Freeland, seen here talking to U.S. Trade Representative Robert Lighthizer and Mexican Secretary of Economy Ildefonso Guajardo Villarreal, has warned about the potential consequences of the U.S.'s NAFTA demands. (Yuri Gripas/Reuters)

One suggestion has been a severe and decisive political meltdown in the Trump administration. Others include an outbreak of global conflict or a serious cyberattack. One report suggests the beginning of the U.S. central bank's plan to reduce its balance sheet could set things off, even though the details and date have been known for months.

But there are also hints a worthy trigger could be an abrupt change in international trade co-operation signalled by the failure of the North American Free Trade Agreement, which remains under tense renegotiation.

Scary stories

Most investors and businesses would obviously be unhappy if markets suddenly tumbled. Nevertheless, for the business media — and many of their readers — market crashes seem to hold a fascination similar to the one that inspires fans of apocalyptic fiction. 

A top story this week in one of the world's bibles of hard financial journalism, Britain's Financial Times, was an article comparing the current markets not just to 1987 but to the Great Crash of 1929 that presaged the Great Depression.

The writers noted that respected Yale scholar Robert Shiller, author of the book Irrational Exuberance, has recently warned that the comparison is not favourable.

 

"The cyclically adjusted price-to-earnings ratio kept by Yale economics professor Robert Shiller is at levels topped only by the peaks before the dotcom bubble burst in 2000 and the Great Crash in 1929," the Financial Times article says.

In the comments below the piece, there are many who offer reasons for why it can't happen now, including the suggestion that, since everyone is now talking about the danger of a new crash, traders all have their eyes wide open.

Greater fool

But someone responding to that comment quotes previous research by Shiller that shows even before the crash of 1987, the vast majority of investors worried the market was overvalued. 

"Speculators typically recognise that they're buying into a bubble, but think they're smarter than everyone else, and will be able to predict the top, then sell before everyone else," says the commenter, who uses the pen name Phoenix.

That's the greater fool argument, well-known in all kinds of investing including the real estate market.

Timing is everything for market traders on the floor of the New York Stock Exchange. (Jin Lee/Associated Press)

That kind of trigger-finger mentality where so many investors are nervously watching for the signal to sell is clearly destabilizing. But so far, every time the market retreats, investors buy on the dip.

That could be changing, according to a piece this week in Wall Street Journal affiliate MarketWatch. What the author describes as professional "smart money" is increasingly betting the market will fall while ordinary investors, described as "dumb money," are upping their stake.

Most great crash analysis in the business press comes to the reassuring conclusion that for a variety of reasons it won't happen this time.

As mentioned, that doesn't mean there aren't plenty of suggestions about what could abruptly change the mood.

One that may not have received enough attention is the danger of a changing global trade climate should NAFTA fall apart.

'Worst possible outcome'

Certainly Canadian Foreign Affairs Minister Chrystia Freeland has expressed nervousness about the rocky state of the trade talks, clearly pointing a finger at "unconventional" and "troubling" demands from the U.S. that could bring the deal down.

"We need to be prepared in a very sensible, pragmatic, dare I say it, a no-fuss Canadian way, for the worst possible outcome," Freeland said this week. "And we certainly are."

A direct warning about the financial impact of a trade breakdown came from an unexpected source this week when the Canada Mortgage and Housing Corporation used the threat of such an outcome to demonstrate it's equipped to deal with the worst kind of crises.

Although it described the event as unlikely, the CMHC said a move toward anti-globalization and increased tariffs could lead to a 31 per cent decline in house prices. The federal corporation did not get into how such an event would affect stock prices, but there is every reason to expect the same logic would apply to securities.

NAFTA critics have expressed doubts that the deal has created miraculous benefits for the U.S. or Canada. Nonetheless, there are widespread fears that the process of unwinding integrated cross-border industries that have grown together over 23 years will hurt should the deal fall apart.

In the event of that outcome, the question is whether a sudden collapse of NAFTA and its implication for future corporate earnings would be enough to alter the current exuberant mood. Just the threat of such a result could be one more reason to try to seal a deal.

Follow Don on Twitter @don_pittis

More analysis from Don Pittis

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