Since late 2012 the world’s major stock markets have been ploughing higher than most financial commentators could have envisaged. The stock price rally of recent months, despite the less than favourable global economic conditions, has earned the dubious nickname the ‘Teflon Maalign="right" alt="" style="margin-top: 0px; margin-right: 0px; margin-bottom: 10px; margin-left: 10px; border:1px solid black;" rket’. In early 2013 both the Dow Jones and the S&P 500 surpassed their historic highs, with other markets- including the Nikkei and the FTSE 100 indexes also looking set to accomplish similar feats. But with weak data coming out of China, a troubled eurozone and a fragile economic situation in the US, investors are wondering whether the rally can continue into 2014 or if it will end in disaster.
 

It is hard to say exactly what is causing this equity investment frenzy of late, but there are a number of factors that are certainly playing an important role. First and foremost there is the fact that loose monetary policies, particularly from the Federal Reserve and the Bank of Japan, have left investors with nowhere else go apart from stock markets. The so called ‘Abenomics’ policies of Japan’s new leadership has led to a severe devaluation of the yen, and in turn has increased the attractiveness of Japanese stocks- particularly those companies which export heavily. Across the Pacific Ocean, sentiment towards the US economy and consistent rounds of quantitative easing (QE) has restored a higher degree of investor confidence. In both cases, it is clear that a liquidity-driven boom is well underway.
 

There has also been a wave of positive economic data coming out of the US early in the year. House prices, for instance, have been increasing tremendously and show clear signs that the recovery is gaining momentum.  As Ryan Detrick, senior strategist at Schaeffer's Investment Research, has pointed out: "The stock market tends to lead the economy. Now we're starting to see the improvement on the economic front, so there's some justification for this rally.”
 

Added to this, there is also a sense amongst some financiers that the eurozone is stabilising and that corporate earnings and balance sheets are now looking healthier after several years of deleveraging.
 

The old saying goes that 'the road to hell is paved with good intentions'. When the proverbial hit the fan back in 2008, the only solution politicians and central bankers the world over had up their sleeves was a lot of QE and a colossal slackening of both fiscal and monetary policy. The problem facing stock market investors now is what will happen when central banks stop intervening and credit markets tighten up again.
 

According to Peter Schiff, President of Euro Pacific Capital and one of the few mainstream economists to accurately predict the 2008 financial crisis, “When you adjust the stock market prices to account for inflation we are nowhere near record highs.” He warns that “The markets are missing the point, just like they did in the run up to 2007 when the financial crisis was around the corner, and they assume that the Federal Reserve has a credible exit strategy which it doesn’t.”
 

Whichever way governments and central banks decide to wind down their stimulus measures over the coming years, it will almost certainly affect investor confidence and the amount of excess liquidity which finds its way to the stock markets. 
 

Given the tremendous gains we have seen in the first half of 2013, it is hardly surprising that a number of prolific commentators are not only pessimistic about stock prices later in the year, but are also warning of an enormous sell off which could lead to one of the biggest crashes in history. 
 

One such critic, Harry Dent of HS Dent Investment Management is predicting that “there will be a massive equity market crash around the world in the third quarter of 2013.” Dent justifies his views by pointing out that “we have seen crashes in 2002, 2007, and even before that there has tended to be a bubble leading to a crash, to some extent, every 5-6 years.” Indeed if history is anything to go by then we could be facing a big correction at some point this year, or next year at the latest. 
 

Investment guru Dr. Marc Faber has also been arguing the case for an imminent correction and he claims that “unless we see a pullback of 10-15% before the end of summer we could see a crash which is reminiscent of 1987, mainly because there is an overbuying of stocks which are still thought to be cheap.” Whether the current rally ends in a huge crash as the doom mongers are suggesting, or it merely comes up to a slight correctional period in late 2013 is debatable. However, the fact remains that the current run cannot last forever and at some point the markets will have to take a downward hit.
 

It is hard to say whether investors are currently buying into equities because they genuinely believe that economic conditions are drastically improving or they feel an overwhelming urge not to miss out on potential profits as the markets continue to move higher. In any case, if there is a big crash coming then savvy investors would be well advised to hold onto some cash and buy stocks when the markets take a tumble.
 

One of Warren Buffett’s most prolific investment philosophies is to “be scared when everybody else is being greedy and be greedy when everybody else is scared.” During the current rally, so many people are getting excited and ploughing their cash into shares that most blue chip companies’ stock are very expensive. Unless you prefer to take a chance on gold or silver prices going through the roof, timing your investments in the stock market wisely will make all the difference. 
 

Whilst a market crash is a catastrophe for those with money already tied up in equities, it is also an ideal opportunity for anybody with spare cash to step in and make big profits on the way back up!

 

By Josh Cooper