Investment research firm Cross Border Capital reckons a bear market might be on its way in 2018 fuelled in part by central bank tightening.
In a report entitled 'Are the G4 Central Banks About to Make Another Major Error by Reversing QE?', the London-based firm looks at capital flows at the global and regional level for indications about how equity markets might perform next year.
In particular it argues that cross-border capital flows - currently moving past peak levels - are an excellent indicator for asset allocators. Crucially the research house feeds this data into statistical probability model informed by machine-learning technique which incorporates the balance between cross-border capital flows and the net liquidity injections or withdrawals by the central banks.
It then assesses the probability of a market correction 15-months ahead according to whether cross-border flows are excessively speculative and Central Banks are withholding liquidity.
This data-driven model has also been tested on back data and according to Cross Border the engine "does a pretty good job of highlighting approaching bear markets."
"At a probability threshold of 50%, it correctly assigned 91% of past bull market periods and 55% of bear markets 15 months ahead. Admittedly, it did appear to give false signals in 1995 and early-2006 when it was 'too early', but otherwise it captured the other major downturns."
Using this model, Cross Border projects "more than a year ahead and this definitively warns that there is already at least an 80% chance of a major correction in 2018, given what we know so far about capital flows and Central Bank activity. A further Central Bank liquidity squeeze can only raise these odds... On current criterion, large-sized investments in risk assets should be scaled-back because cross-border flows are historically high and the major Central Banks are collectively starting to tighten. Thus, a risk we can foresee is that these sizeable cross-border flows may suddenly collapse, as they did in 2008. We must keep a close track over coming months."
