October financial crash possible

Let's take a step back in time to October 1987. Stock markets were strong, property prices rising rapidly, economies in expansion mode. Then suddenly it was Black Monday and the worst stock market crash since 1974. What went wrong?

With hindsight we can see that both stocks and property were overvalued, and that the market had got well ahead of itself. But the trigger was an ill-judged US policy that sent the US dollar into free-fall and led to foreign investors rushing to exit the US markets thus causing Wall Street to crash.

Have the US authorities made the same mistake again? Certainly this week the IMF Managing Director Horst Koehler warned about the dangers of remarks in Washington last week designed to weaken the dollar.

The danger is that sudden devaluations can get out of control. As an investor why would you hold US dollars if you felt that the value of the greenback was about to fall? If everyone heads for the exit at the same time, we have another market crash.

Again looking back to 1987 the crash proved a blip on the path of economic expansion in the US (although that could not be said of the terrible UK recession). And it may be that a US stock market correction this time would again prove to be a small bump on the road to economic growth.

So are stocks and property overvalued? Any chartist will tell you that stocks are certainly well above their historic valuations. And in many markets property prices have soared to record levels on the back of low interest rates.

The truth is probably that the Bush Administration is playing dangerous games in order to export US economic problems abroad through devaluation of the dollar. If it works the US economic recovery will become established, and George Bush will be re-elected next year.

If it does not then the systemic risk of a sudden drop in the value of the US dollar is considerable, and the President will be kicked out. Hence the high gold price which is how investors can hedge in times of market uncertainty.

Meanwhile, dollar depreciation and the OPEC induced high oil prices are likely to cause inflation to increase. Stock markets do not traditionally like inflation either.

So should investors sell their stocks and leave the market? Not if you believe the talk of the economic recovery, but on fundamental indicators yes!