New Data Suggests a Stock Market Crash May Be Imminent
It’s been a buckle-up-and-hold-on sort of year for Wall Street and retail investors. The unprecedented uncertainty created by the coronavirus disease 2019 (COVID-19) pandemic shaved 34% off of the benchmark S&P 500 (SNPINDEX: ^GSPC) in a matter of just 33 calendar days during the first quarter. We also witnessed the fastest snap-back rally to new highs from a bear market low on record. All in all, we’ve crammed about a decade’s worth of volatility into a six-month window.
The scary thing is, we may soon be doing it all over again.
This new data tells a scary tale
Aside from volatility, one thing the stock market isn’t short of these days are doomsday predictions — and you’re about to hear another one.
Previously, I’ve suggested that a stock market crash or correction was highly likely because historical data said it was. Following the previous eight bear markets, dating back to 1960, there were a grand total of 13 corrections/crashes of between 10% and 19.9% within three years of these bear market lows. This is to say that each new bull market underwent one or two sizable corrections relatively soon after bouncing off a bear market low.
However, this may not be the most damning evidence that the stock market is in trouble. The most concerning data point comes from Refinitiv Lipper, which has been reporting U.S. weekly mutual fund and exchange-traded fund (ETF) cash flows on a weekly basis for well over a decade. For the week ending Oct. 21, 2020, investors were net redeemers of fund assets (conventional funds and ETFs) to tune of $7.6 billion.
Here’s what’s concerning: This was the 11th consecutive week of fund outflows, when taken as a whole, and the 26th consecutive week for conventional fund outflows (excluding ETFs). Domestic equity funds are also riding a 19-week streak of ongoing outflows. The stock market might be near its all-time high, but this data suggests that investors aren’t exactly thrilled with the prospect of putting their money to work in equities right now.
What makes this even more worrisome is that these ongoing outflows come at a time when U.S. Treasury yields are within a stone’s throw of their record lows. Investors looking for guaranteed income are scraping by with only a 0.8% yield on the 10-year Treasury note. It’s almost certain that inflation will outpace 0.8%, on average, over the next decade, meaning T-bond buyers are going to lose real money while holding to maturity.
If investors aren’t tempted by equities with yields that are virtually nonexistent, Wall Street could be in some serious trouble.
Don’t forget these issues, either
Keep in mind that equity fund outflows are just one of many potential problems for the stock market.
The coronavirus pandemic remains an issue in many respects. Putting aside a vaccine for a moment, there remains the possibility of additional restrictions both within and outside the United States. Ireland, for example, is imposing a six-week lockdown that requires residents to stay within three miles of their homes and restricts access to retail stores and restaurants. With each state in the U.S. managing its coronavirus response independent of the federal government, it’s not out of the question that additional restrictions could become necessary this fall or winter.
As for a COVID-19 vaccine, Wall Street appears to be expecting a miracle. I mean, why would the S&P 500 be within striking distance of a new all-time high if not for the expectation of a vaccine with exceptional efficacy? If late-stage trials fail to completely wow Wall Street, a lot of downside could await the market.
Fundamentally, I think it’d also be foolish (with a small “f'”) to overlook the strong likelihood of a rise in delinquency rates for mortgages, rent, credit cards, and personal loans in the coming months. Remember, funds from the Coronavirus Aid, Relief, and Economic Security Act served as a financial buffer for tens of millions of Americans through July. But with enhanced unemployment benefits now gone and the unemployment rate still more than double where it was prior to COVID-19, our nation’s financial institutions are bound to feel the pain.
Even election uncertainty could become a problem. Although the polls appear to be in agreement that Democratic Party challenge Joe Biden will be victorious on Nov. 3, surveys have proved wrong before. Anything but the utmost certainty when it comes to politics usually plays out poorly on Wall Street.
Three things to do if a stock market crash does occur
Suffice it to say, a stock market crash remains a very real possibility in the near future. The question is, what should you do if one occurs?
First of all, don’t panic. Though investor emotions tend to run amuck during periods of heightened short-term volatility, downside moves in the stock market are actually far more common than you might realize. There have been 15 corrections of at least 5.8% in the broad-based S&P 500 since 2009, and 38 moves lower in the S&P 500 of at least 10% since the beginning of 1950. This works out to an official correction every 1.84 years. In other words, crashes and corrections happen with regular frequency, and they’re the price of admission to the greatest wealth creator on the planet.
Second, use crashes and corrections as an opportunity to reassess your portfolio. Rather than running for the exit, take the time to see if the reason(s) you bought into a company still hold water. Chances are that short-term volatility in the stock market isn’t going to have an impact on your investment thesis. Reassessing your holdings will keep you from making hasty decisions.
Third and finally, feel free to go shopping, if you have dry powder at the ready. Since every single crash and correction has eventually been erased by a bull market rally, all major declines in the stock market represent opportunities for long-term investors to pick up great companies at perceived-to-be discounts.
The best thing about this three-point strategy is you won’t have to know when a crash will occur, how long it’ll last, or how steep the drop will be to make money over the long run.
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