Does a “Lehman-Like Shock” Lie Ahead?

As the stock market this week posts dizzying ups and downs, Wall Street experts increasingly warn that the proverbial “stuff” is about to hit the fan.

Masanari Takada, an influential strategist at Nomura (NYSE: NMR), asserted in a note published Tuesday that Monday’s trade war-induced stock market plunge unfolded as he predicted. However, Takada also said that the rebounds (as we experienced yesterday) are probably paving the way for a stock market crash.

In fact, Takada warned that the crash could be comparable to the one triggered by the collapse of Lehman Brothers in September 2008. Here’s the stark language he used to describe his doomsday scenario:

“Once the first wave of volatility has passed, global equity markets are likely to experience a spontaneous rebound. Contributing factors to such a relief rally could include expectations for a substantial rate cut by the Fed at the September FOMC meeting and stock purchases made by short-term contrarian investors.

However…we would expect any near-term rally to be no more than a head fake, and think that any such rally would be best treated as an opportunity to sell in preparation for the second wave of volatility that we expect will arrive in late August or early September. We would add here that the second wave may well hit harder than the first, like an aftershock that eclipses the initial earthquake. At this point, we think it would be a mistake to dismiss the possibility of a Lehman-like shock as a mere tail risk.”

Yikes! As you probably remember, Lehman Brothers was a powerful global financial services firm and venerable brand name on Wall Street. Lehman’s implosion in 2008 triggered a domino effect culminating in the global financial crash and Great Recession. Here’s a timeline for context:

Source: Thomson Reuters Eikon, Investing Daily

Takada based his analysis on damage from the trade war, disappointment over the Federal Reserve’s unwillingness to get more dovish, slowing global economic growth, and data suggesting that hedge funds are fleeing the market.

You wouldn’t know it from yesterday’s bounce back. The three main U.S. stock indices soared Thursday as better-than-expected reports on the U.S. and Chinese economies cheered investors.

The Labor Department reported yesterday that the weekly number of new jobless claims was lower-than-expected. Initial claims for state unemployment benefits fell 8,000 to a seasonally adjusted 209,000 for the week ended August 3, compared to the consensus estimate of 215,000. The numbers indicate that the U.S. labor market is still expanding despite global economic headwinds.

The positive jobs data assuaged previous anxieties about trade and currency wars. Investors also were glad to see the People’s Bank of China take steps on Wednesday to stabilize the country’s national currency, the yuan.

But analysts like Takada are sounding the alarm. Earlier this week, economists at Morgan Stanley (NYSE: MS) warned that if the trade war continues to escalate, a global recession will hit within nine months. Morgan Stanley, Goldman Sachs (NYSE: GS), and JPMorgan Chase (NYSE: JPM) have all predicted that we probably face a correction of at least 10% in the third quarter. The bears are coming out of hibernation.

Political turmoil isn’t helping Wall Street’s mood, either. President Trump continued to attack the Federal Reserve yesterday, demanding “substantial” Fed interest rate cuts to allow the U.S. dollar to fall in value against foreign currencies.

Trump thundered on Twitter: “As your president, one would think that I would be thrilled with our very strong dollar. I am not!”

Trump complained that the Fed is keeping interest rates too high in comparison to other countries, thereby bolstering the greenback and undermining the competitiveness of U.S. manufacturers.

It’s extraordinary to see a president excoriate the U.S. central bank, which is supposed to remain independent from political pressure. It’s yet another “new normal” in Washington that unnerves investors.

Bracing for Armageddon…

If a Lehman-like catastrophe occurs, will you be ready?

Financial contagion could easily spread at any time, sparked by a host of factors ranging from trade war to terrorism to poor economic data, pulling down overpriced but fundamentally weak stocks that are living on borrowed time.

Read This Story: 7 Survival Steps for The Next Market Panic

To be sure, severe and sudden market drops are not uncommon. The S&P 500 has marched upward over the long term, but the climb hasn’t been a straight shot. Investors over the decades have been treated to sharp dips along the way.

We now seem overdue for a correction. Many stocks, especially in the technology sector, currently trade at valuations high enough to give investors nosebleeds. And yet, corporate earnings growth is slowing.

Whenever there’s carnage on Wall Street, stay focused on the long-term horizon. Chances are, you’re saving for retirement or another multiyear goal. With that in mind, keep your eye on the long game. Don’t panic and throw your investment strategy out the window.

Resist the urge to make dramatic swings in your allocations. The risk is that you might sell your stocks right before they recover. During a steep market decline, don’t get overwrought and make knee-jerk decisions that will be difficult for you to undo.

Yes, the crash of 2008 was horrific. Lehman is gone. But the investment world survived to live another day.

Questions or comments? I’m here to help:

John Persinos is the managing editor of Investing Daily.