Business

Is There A Possibility Of Another Stock Market Crash?

Unless you have been on a deserted island with no form of communication, you would know that there is a lot of scare mongering around the possibility of another stock market crash. Some people call it “terrible October” while others refer to it as “red October”, but any way you look at it, October 2018 has continued to live up to its reputation as one of the most volatile months in the stock market. October has had a long reputation of being a down month in the market given that previous significant crashes have occurred in this month including the great crash of 1929 (black Tuesday) and black Monday in 1987. To this day, we continue to be reminded of these crashes, which is why people are so wary when October rolls around. But should we be concerned or is the current bearishness just the market being normal?

Another Stock Market Crash
mohamed_hassan / Pixabay

So far October has produced a new all-time high on the Dow with the S&P having an all-time high in September. Charles Dow, founder of the Dow Jones Index, said that for crashes to occur we need to see rampant speculation in the market with hordes of inexperienced investors jumping into anything that is moving at increasingly higher rates. We also need to see record levels of borrowing to invest and investors moving into mutual funds.

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Whilst consumer debt is up, I believe it is more a sign of a good economy and not rampant speculation from individuals borrowing to get into the stock market or to invest in mutual funds. If we consider the new inflows into mutual funds, the levels have decreased over the past couple of years.

Looking at the market from a technical perspective, we have more than 200 years of market data that proves the stock market has cycles of 80 to 90 years, with the last major cycle low occurring in March 2008, which is also known as the GFC low. Prior to this, the major lows occurred in 1932 (the 1929 crash), 1842 and 1762. Out of the 1932 low, where the Dow had fallen 90 percent in price between 1929 and 1932, the Dow rose for 56 months and 382 percent in price before falling 50 percent into a low in March 1938. During this time, we first experienced a depression and then the 1937 recession, which caused the fall into the low in 1938. The next major fall for the Dow did not occur until the 1970’s, where it fell just over 30 percent.

The move out of the 90 year low that occurred in 2008 has been quite different to the move up from the 1932 low in that we have seen the market rise 115 months and 316 percent, so the rise has been steadier rather than the euphoria experienced in 1932. We have also not seen a depression, and a short-lived recessionary environment. Once the dust settled after the GFC, the economy started improving to now being strong and indicating that a continued rise in the market is likely sustainable.

Given that we are a mere ten years on from the last 90 year low and the next one is not due until the end of this century, right now I believe we are seeing a normal market adjustment to the current longer-term bull market. Therefore, my expectation is that any fall on the Dow will be in the vicinity of 15 to 25 percent from its all-time high with support between 22,000 and 21,000 points.

We also need to be cognisant of the fact that for a market to crash to occur we need to see fear and panic, which is fuelled by widespread concerns over leveraging by consumers and as previously mentioned, we have not seen this in the stock market, but what about leveraging in the housing market, which was the major cause of the GFC.

While there is some justification for concern in the housing market, it is more around availability given that not enough new housing is being built to handle the growth in the population. Most of you will remember all the talk in 2007 was about dubious mortgages and lending practices and at the time interest rates were over 3.5 per cent, well above today’s level of 2.25 percent. So, in summary we are not seeing large scale stress in lending for housing.

I have often said that if the majority are suggesting that a crash is imminent, then the market will not crash. This is because those who are likely to panic would have already sold out and the big end of town would have battened down the hatches and adjusted their portfolios. The process of protecting portfolios from downside risk has the effect of slowing the market as the reweighting of portfolios occur, and while over the past weeks we could say there has been signs of this, it has not been widespread over many months, which indicates that the big end of town are not too worried.

In my book, it does not matter which way the market, or a stock for that matter, is heading or how far it moves in that direction, what is critical for investors is the process they take when it does move. We cannot control the market, but we can control what we do, which is to control when we get in and when we get out.

Investors are known for following the herd and making reactive decisions, rather than being proactive, and it is well known that the herd get it wrong most of the time when it need not be the case. In my latest book, Accelerate Your Wealth, I show that with some simple but powerful strategies, anyone can avoid getting caught in a crash, and more importantly reduce their risk and increase profits.