What’s a ‘hyper-crash’ and are we headed for one?

The world’s markets are heading for a “cataclysmic crash”, if past performance is anything to go by, a team of Polish mathematicians are warning.

And, the unprecedented financial meltdown will make the fall of the Lehman Brothers, the bursting of the dot-com bubble and Black Monday look like “minor stumbling blocks” in comparison, the researchers from the Institute of Nuclear Physics of the Polish Academy of Sciences in Krakow warned in a recent paper for the journal, Complexity.

“The data is, unfortunately, quite unambiguous. It seems that since the mid-2020s, a global financial crash of a previously unprecedented scale is highly probable,” Professor Stanislaw Drożdż of the Krakow University of Technology said.

“This time the change will be qualitative. Indeed radical!” he added.

The mathematicians, Drożdż, Rafał Kowalski, Paweł Oświȩcimka, Rafał Rak, and Robert Gȩbarowski came to this conclusion after analysis of the S&P 500 stock market index from January 1950 to December 2016.

Sounds concerning. Why do they think this is going to happen?

The researchers analysed the “Hurst exponent”, an indicator which shows the likelihood of a market experiencing change through ratings from 0 to 1, and found stable markets have ratings around 0.5.

However, Black Monday, or the October 19 1987 fall saw the Hurst exponent fall below this.

Around 20 years later, the collapse of the Lehman Brothers investment bank and the ensuing Global Financial Crisis triggered another fall in the Hurst exponent. It’s not yet recovered.

The researchers consider this, and the fact the exponent has lingered beneath 0.4 since, an ominous sign.

Drożdż said the increasing frequency of falls coupled with the inability of the Hurst exponent to return to stable levels is also alarming.

“We have a clear signal here that the nervousness of the world market is growing all the time, for decades, regardless of changing people, business entities or technology.”

When could it happen?

In 10 years or so. However, a statement from the mathematicians said the aim of the research was not to deliver “catastrophic forecasts” but to demonstrate the similarities between past events and the likelihood of a future event.

Drożdż acknowledged the sheer pessimism of the forecast but warned that if financial markets don’t change qualitatively in coming years, this worst-case scenario could become reality.

He said the use of cryptocurrency could potentially shift global markets away from this reality and noted that mathematical analysis and financial markets don’t always align.

And, he added, the only ones who won’t lose out on the forecast are the researchers; “If the hyper-crash does occur, we will have shown the power of our… statistical tools in a spectacular way.

“Personally, however, I would prefer for this not to happen. If this is the case and the hyper-crash does not occur, we will still have the quite acceptable interpretation that our forecast was… correct, but today’s press release will have influenced the behavior of market participants and, well, we have just saved the world!”

Inverted yield curve another warning sign

Less spectacular but similarly concerning, the inversion of the US Treasury yield curve is something to watch, according to analysts.

The yield curve is the difference between interest rates on short-term and long-term bonds. Long-term bonds tend to pay higher interest, so a normal yield curve has interest rates going up. An inverted yield curve is unusual and indicates long-term bonds are delivering lower rates of interest.

And, a flattened yield curve is generally a sign that traders and investors have concerns about the macroeconomic outlook – the US yield curve flattened significantly in 1990, 2000 and 2007 – these were all periods preceding recessions.

Just this week, the US Treasury yield curve inverted, sounding another alarm. It’s the first time this has occurred since 2007.

The inverted curve shows investors think the government is less likely to pay back the debt it owes in two years than what it owes in a decade. In the current instance, it indicates investors think the government is less likely to pay up in three years than in give.

The US Treasury yield curve inverted between the 2- and 10-year yield before the 1981, 1991, 2000 and 2008 US recessions and has preceded all nine US recessions since 1955.

“It looks like we’re going into a slowdown. The bond market in the US is saying recession and the bad news is that so far the bond market in the US has never been wrong on this,” the head of investment solutions design at Fidelity International, David Buckle said in November.

“Whenever the US bond market has said recession, there’s been one and there’s never been a recession without the US saying it’s going to come.”

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