If we needed any further evidence that markets are in an extremely fragile state, it came last week. First, we had the strong reaction to the Greek crisis. It illustrated that even a bit player on the global financial stage can have an inordinate impact on jittery investors who seem to be holding their breath in expectation of bad news.
Then, there was the overreaction to China's latest modest effort to cool an overheated credit market. Banks were ordered to boost their reserves for the second time this year. This is not exactly the same as putting the brakes on growth. The Chinese economy is still expected to expand by about 10 per cent this year, and there is no shortage of capital sloshing around the system to support Beijing's aggressive stimulus-at-any-cost policy.
But North American investors keep looking for trouble and, heading into a holiday weekend, the China stuff qualified.
None of this comes as a surprise to Hal Vogel, a Wall Street veteran who runs his own investing and consulting firm. As a firm believer that the market is about to head south, Mr. Vogel is shorting equities these days. "We're due at least for a pretty good correction. It could be more serious, but it's too early to know."
A crash would be too strong a word to characterize what he expects is now under way. "Collapse is more appropriate terminology," he says.
And what, pray tell, is the difference?
Well, it turns out that a collapse is slower, less steep and a lot less frightening, because it means positions are being unwound gradually. A crash, on the other hand, involves a panicked selloff at any price, as investors rush for the exits.
Mr. Vogel ought to know. He's an expert on crashes, and bubbles, too, for that matter.
When I first encountered him in the 1990s, he was a top Wall Street analyst covering the entertainment and media world, and the author of a definitive text on the economics of the industry. But his formidable analytical skills were no match for the dot-com explosion, when companies with no earnings, revenues or even prospects were wowing wide-eyed investors and raking in billions through IPOs.
This led Mr. Vogel on an intellectual quest to understand such bubbles and, ultimately, to devise a method of analyzing, measuring and comparing them. And if you know bubbles, you're going to know what happens when they burst.
His new book on the subject, Financial Market Bubbles and Crashes (Cambridge University Press), is an expansion of the thesis that got him his doctorate in 2008 at the age of 62.
"This can grind its way into a crash," he says of current conditions. "It doesn't have to."
He traces the great stock market rebound of 2009 to the influx of government capital into the financial system, which spilled over into all the liquid securities markets.
Human nature also came into play. "People came to feel that the worst was over. They were looking ahead to better [corporate]earnings prospects, and they are very easily better than expected, because companies have cut a lot of costs."
Under such circumstances, a big rally from the lows of last March was a fairly normal response. But now we have arrived at a major crossroads on the way to recovery.
If the economy picks up and absorbs the extra credit pumped out by the most accommodating central banks the world has ever seen, interest rates will rise and the flow of money into speculative markets will slow, as credit starts to be diverted to expansion of real businesses.
The alternative: The sputtering engine stalls, credit stays parked in liquid markets and we end up with the dreaded W-shaped recession grimly predicted by the permabears. It's a club Mr. Vogel has plainly joined after assessing data showing a distinct lack of credit expansion by U.S. commercial banks.
"That would be my conclusion right now," he says cheerfully. "I'm not calling a crash. But I can see a down leg and an extended period of disappointing stock market performance."
Meanwhile he's keeping a sharp lookout for any signs the correction is about to morph into something far worse.
"If this grinds onward and commercial bank lending does not increase, then there will be a point of recognition where everybody says, 'Holy cow, there's a problem here.' And that's when you get your crash."