14 Warning Signs That a Stock Market Crash Is Coming
The longest bull market in history ran from 2009 to 2020, until covid-19 began sweeping the globe and caused stock prices to crash. While economic conditions worsened for some time, the bear market only lasted a few months and then the bulls took control once again. Were it not for the coronavirus, markets could theoretically continue to enjoy the longest bull market in history.
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That’s exciting and scary. History tells us that the market is a cyclical beast, but when its ebbs and flows are out of balance, serious corrections occur.
Reading: How to know when the stock market will crash
With stock prices hitting all-time highs, even in the face of economic hardship and rising debt loads, and key valuation metrics telling investors to turn around, a huge Question. Is a stock market crash just around the corner?
warning signs a stock market crash is coming
To determine if it’s headed for a recession, it’s important to pay attention to the warning signs that the market practically screams at euphoric investors who often don’t listen. in fact, it is the euphoria of dramatic gains that often leads investors down the wrong path, resulting in the market crashes that follow.
But what exactly are those warning signs? and do they reliably say an accident is imminent?
1. prolonged dovish monetary policy
The Federal Reserve Bank of the United States, also called the Fed, is the central bank of the United States, which means that the bank is in charge of determining the monetary policy of the United States.
Considering that the stock market, at its core, is nothing more than a system that allows the movement and balance of cash and value, the fed plays an important role in market activity.
when the federal reserve concludes that the us. the economy is in trouble, moving forward with one of two key policy adjustments, or a combination of them:
federal funds rate
The fed funds rate is the interest rate charged between banks to lend excess funds overnight. When this rate is lower, interest rates on loans like mortgages, car loans, credit cards, and more get lower, spurring a wave of lending.
Of course, when consumers can borrow more money relatively cheaply, they tend to do so, creating tons of liquidity in the us. uu. economy. As a result, spending occurs, leading to higher revenues and profitability for corporations, and ultimately a bull market.
However, prolonged low rates can be a very bad sign because they can’t last forever. At some point, debt will have to slow down and rates will have to rise, resulting in a contraction in consumer spending and, if the contraction is significant, a stock market crash.
Currently, the fed funds rate sits at 0.25%, a very dovish sign, and has been there for years. As recently as early 2020, the Fed expected this rate to remain at incredible lows for at least a few more years. more recently, however, the federal reserve announced that it aims to raise the fed funds rate by the end of 2022. as we get closer to the hike, there is a strong possibility that investors will become increasingly bearish, which could cause a market crash.
bond purchase programs
Another way the Federal Reserve works to stimulate growth in the economy is by buying bonds. By buying massive amounts of bonds, the Fed exchanges liquid cash today for bonds with future maturity dates. This floods the market with spendable money and leads to the same flexible spending that low rates often encourage.
As with low fares, the party doesn’t last forever. At some point, the purchased bonds will mature, but even before then, the Fed is likely to scale back its bond-buying activities. Some members of the Federal Reserve suggest that these activities could slow down by the end of 2021. While this is happening, many companies expect reduced revenues because consumers tend to spend less, which has the potential to cause a market crash.
2. a bubble in market valuations
Bubbles appear in the stock market all the time. some of the most memorable in recent history include the dotcom bubble in the late 1990s and the housing bubble in the 2000s:
the dotcom bubble
In the late 1990s, excitement around the widespread adoption of the internet was high. stocks representing virtually every online company soared, leading to extravagantly high valuations in the sector.
With investors making such massive returns, no one seemed to be paying attention to the inordinately high prices they were paying to own small businesses that, in many cases, weren’t making a dime. when the bubble burst, the entire market was affected.
the housing bubble
After the dot-com bubble burst, excessive monetary stimulus combined with poor lending practices led to a rush of demand for real estate, sending property prices skyrocketing. when the housing bubble burst in 2007, a sell-off began and the great recession was unleashed.
After the great recession, the stock market enjoyed the longest bull run in history, rising for more than 10 years before covid-19 took its toll. by mid-2021, the market had largely recovered fully, with many stocks trading at all-time highs – hundreds or even thousands of basis points above pre-pandemic highs, suggesting to some analysts that bubbles are taking place once again.
3. a prolonged bull market
It is believed that the market is a balanced system, but the reality is that it is anything but balanced. Day to day, month to month, and even year to year, the stock market struggles to keep valuations in check as bears and bulls argue their points.
Whenever the bulls take control for too long, the prices investors pay to own stocks skyrocket, often creating excessive overvaluations. On the other side of the coin, too much control by bears causes stock prices to crash, resulting in extreme undervaluations.
In fact, active traders make it their life’s work to take advantage of the inconsistent equilibrium in the market.
Look at the amount of time the market trend has been up. According to Forbes, the average bull market lasts about two years and seven months. an uninterrupted bullfight that lasts considerably longer could be a sign that we are about to turn a corner.
4. corporate profits stagnate
One of the key drivers in the stock market is profit, and for good reason; no one wants to invest in a company that is losing money with no signs of profitability ahead. when earnings are growing, investors are happy and willing to accumulate more money in stocks.
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Value investors use the price-earnings ratio (P/E), which could also be called the price-earnings ratio, as a key ratio in determining whether a stock is undervalued or overvalued. In other words, a company’s earnings help determine the fair price of its stock.
A clear sign that a market downturn is coming is when earnings start to plateau.
Investors are only happy when the companies they invest in are seeing increasing returns. If earnings stop growing, doubts are raised about the company’s ability to continue to grow, leading many investors to jump ship and sending share prices down.
During times of economic uncertainty, when consumer confidence is at its lowest, consumer spending often dries up, leading to plateaus in the profitability of many companies and widespread stock sell-offs.
As of September 2021, corporate earnings continue to rise. A combination of loose federal monetary policy and stimulus provided through cash payments has led to increased spending, and corporations and investors are reaping the rewards.
There is no doubt that federal policy is in the market’s interest right now, but many are beginning to wonder what will happen when stimulus-related spending stops and profitability declines.
5. a high cyclically adjusted price-earnings ratio (cape)
Continuing with the profitability theme, another clear warning sign that a market downturn could be on the horizon is a high cyclically adjusted price-earnings ratio (cape). The ratio is a 10-year moving average of the traditional price-earnings ratio, which measures a company’s profitability relative to its stock price.
Developed by Robert Schiller in 1996, the metric has been used by economists and stock market experts alike for more than two decades. Also called the Shiller P/E, the capitalization ratio averages price-earnings ratios over the past 10 years, which largely removes short-term peaks and troughs and volatility to show whether the market is truly undervalued or overvalued. .
A healthy coat is in the 15 or 16 range. Anything above 20 is cause for concern, and when the figure approaches 30, it’s a clear warning sign that something big is on the horizon. If you look at the s&p 500 index layer just before the great depression, you’ll see that it went up to 33.1.
As of September 2021, the capitalization ratio appears to be sounding alarm bells, with the S&P 500 Index reading at just over 38 for the month, according to ycharts.
6. rising inflation
some inflation is natural. As the economy progresses, a slow and steady rise in the prices of consumer goods, services, and every other category is normal. That’s why your great-grandparents could buy a full lunch for a penny, and today it’s hard to find a stick of gum for that price.
inflation becomes a problem when it happens too fast. the United States. The Federal Reserve has a stabilized inflation target of 2%, which it considers to be the healthy rate at which prices should rise.
Before market crashes, rapid inflation tends to set in. this creates a major problem.
As prices rise, consumers become more tax-conscious, often leading to an increase in saving activities and a decrease in overall spending. from there, reduced corporate profitability is on the horizon, which has the potential to lead to a stock market crash.
As of September 2021, inflation was exceptionally high in the US. uu. according to the usa Bureau of Labor Statistics, prices rose 5.3% year over year in August, which was surprisingly similar to the 5.4% year over year growth that took place the month before the Great Recession.
7. the buffet indicator
The buffett indicator is a fundamental measure of whether the stock market is undervalued or overvalued as a whole. It was first proposed in 2001 by iconic investor Warren Buffett. Since then, the indicator has been used by economists and Wall Street pundits almost religiously.
the indicator compares the total value of the us. stock market to the united states gross domestic product or gdp.
according to buffett himself, the market is valued fairly when the indicator is between 75% and 90%. once the indicator rises to between 90% and 115%, the market is slightly overvalued. finally, whenever the indicator is above 115%, the market is highly overvalued and ready for significant declines.
so what does that say about the market in 2021?
As of September 29, 2021, the indicator stood at over 239% based on current market valuation, suggesting that the market is extremely overvalued and that drastic drawdowns are likely.
8. excessively high market sentiment
Emotion is a key driver of movement in the stock market. when fear hits hard, market prices drop as investors sell their holdings, and market prices rise as investors buy shares when euphoria and greed set in.
In some cases, emotions can run extremely high, leading investors to throw all fundamental analysis out the window and make emotionally driven decisions that drive prices to extreme undervalues or overvalues.
When the market becomes overly euphoric and overvaluations are rampant, it’s a sign that a downturn is imminent. one of the best ways to measure this is by using fear & amp; greed index. Developed by CNN Money, the index was designed to measure whether investors are too bullish or too bearish based on the two main emotions driving the market.
In September, the index reached 34, which suggests that the general sentiment towards the market is fearful. with the market turning fearful after a long-term greedy streak, and sentiment weighed down, the downside could be yet to come.
9. internal and geopolitical uncertainty
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Politics will always play a significant role in stock market activity. Legislative changes have the potential to completely recover or destroy large sectors of the economy, whether those political changes happen here at home or around the world.
Political uncertainty is a common concern ahead of market declines. After all, when investors don’t know what to expect, they are unwilling to risk their money, leading to less investor interest and falls in market values.
in usa In the US, political uncertainty was high during the 2020 election season and has remained a concern ever since. Expectations that President Joe Biden will raise corporate tax rates from 21% to 28% have raised concerns that the political environment may not be the best for investors.
Since the initial expectations of tax increases, a few other concepts have come to the table. biden has talked about raising the minimum corporate tax rate to 15%, and more recently, lawmakers are considering raising the corporate tax rate to 26.5%
Although no one knows where the rate will end, a corporate tax hike is almost imminent, which could reduce profitability and cause market declines.
On the international stage, many argue that geopolitical uncertainty will continue for some time as China, Russia and Iran vie for power and many Western countries face domestic political turmoil.
Continuing uncertainty or major political events could weigh heavily on the market.
10. an inverted yield curve
An inverted yield curve occurs when long-term coupon rates on fixed-income securities fall below short-term rates. The term invested is used to describe this stock because long-term fixed income investments generally pay a higher return than their short-term counterparts.
When the curve inverts, it suggests that investors believe that economic difficulties are ahead and that rates will fall in the long term. Historically, this has been a convincing sign of crashes to come. in fact, for the past 50 years, an inverted curve occurred just before every recession, with only an inverted curve occurring but not followed by a recession.
So far in 2021, the yield curve has moved rapidly up. however, in recent months, the growth of the curve has begun to slow down and a flattening trend can be seen on the horizon.
11. weakening of economic indicators
economists use various indicators to determine the state of the us. uu. economy at any given time, which is important in determining whether a crisis is brewing. Investors tend to withdraw from stocks when economic conditions are bad.
many investors turn to the conference board’s leading economic index, or lei, which takes into account the following indicators:
- manufacturing. when more manufacturing occurs, it is a sign that economic conditions are positive. The lei tracks both average weekly manufacturing hours and new orders for manufactured consumer goods, materials and non-defense capital goods, excluding aircraft orders.
- unemployment claims. when economic conditions are booming, there tend to be fewer jobless claims; the opposite is true when economic conditions are a concern.
- housing market. if economic conditions are positive, consumers are more likely to jump into buying a new home. therefore, if there is a slowdown in the housing market, including home sales, building permits, and new private housing units, there is likely to be a slowdown in the economy as a whole.
- stock prices. the United States. the stock market and the state of the economy are strongly correlated. The lei takes into account share prices in the s&p 500 index to determine whether the market is reacting to economic uncertainties.
- credit index. Consumers are more likely to take out new loans when they feel economic conditions will make repaying those loans relatively easy, and they are less likely to borrow when economic conditions are worrisome. the United States. The credit ratio measures the performance of corporate, fixed-rate, and taxable government securities, which helps determine the state of the economy based on returns in the fixed-income sector.
- yield on treasury bonds. finally, the lei compares 10-year treasury bond yields minus the federal funds rate. The difference is the premium investors are willing to pay for medium-term treasuries, further pointing to investor sentiment around the us. uu. economy.
As of the August reading, the lei rose to 116, which is an all-time high, suggesting that economic conditions have fully recovered from lows related to the covid-19 pandemic. On the other hand, many argue that these numbers are skewed by stimulus, prolonged low rates, and bond buying.
12. decline in vehicle sales
vehicle sales are an excellent indicator of what is happening in the us. uu. economy. therefore, they can be a great sign of an upcoming stock market crash.
Buying a new vehicle is a big decision that comes with a significant price tag. Most people take advantage of loans when buying vehicles because they simply can’t afford to buy them comfortably with cash.
As a result, vehicle sales tend to be positive when consumers believe positive economic conditions are ahead and seem to hit a brick wall when the general sentiment turns negative.
By looking at vehicle sales growth, you’ll get a sense of how consumers feel about economic conditions and their confidence to make major purchases. This matters because consumers’ feelings about the state of the economy often dictate their spending and saving habits, which boils down to rising or falling incomes for many businesses.
according to forbes, vehicle sales fell more than 13% year over year in August. While some say this points to a market downturn ahead, others point to a recent chip shortage causing automakers to cut production of new vehicles, which is a factor in the declines.
13. decline in home sales
The rationale for tracking home sales is similar; consumers are not so arrogant about buying a home if they are not comfortable with the state of the economy.
Right now, existing home sales are on the rise, up 2% in July according to the National Association of Realtors. if sales continue to rise, it will be a strong signal that consumers are confident in the economic growth to come.
14. a black swan event
In a black swan event, none of the above matters. These rare and unforeseen events occur completely out of the blue, leading to dramatic market crashes. Some examples of black swan events in recent history include:
- covid-19. the most recent black swan event took place in early 2020, when covid-19 swept the globe. the virus came out of nowhere, causing crashes and a tremendous market crash in a short period of time.
- terrorist attacks. On September 11, 2001, a terrorist attack on New York City and the Pentagon shook the United States. the resulting fear of further attacks and geopolitical fallout led to significant market declines.
- dissolution of the soviet union. The collapse of the Soviet Union took place in 1991. The geopolitical uncertainty that followed drove markets to tremendous lows.
By their nature, black swan events are rare and unpredictable. There is no way of knowing if a black swan event will happen tomorrow or 10 years from now, but when it does happen, it tends to cause big market declines.
Whenever there is a bull market, fearful investors wonder when the bears will take hold and the market will crash. It’s no surprise that as prices hit record highs, many are wondering when the next drop will come.
As of this writing in September 2021, there are clear signs that an accident could be on the horizon. while not all signs point to a bust, much of the positive economic data has been driven by monetary stimulus led by low rates and bond buying, which simply can’t last forever.
The good news is that downturns don’t last forever either, and even in the face of a downturn, wise investment decisions can pay off, which is why it’s so important to do your research before investing.