Will the stock market crash again? | Smart Change: Personal Finances

(Ryan Downie)

It’s been a tough year so far for the stock market, and investors fear things could get worse. Now is not the time to panic, because fear can ruin your investment plan. However, now is a good time to assess the market situation and review your portfolio allocation to make sure you’re ready for what’s next.

Some historical perspectives

The short answer to the main question is yes. The stock market has crashed many times in the past, and it will crash many more times in the future. Stock valuations rise and fall with supply and demand, and supply and demand are influenced by a variety of factors. Greed, fear, FOMO, and business prospects all play a role, as does the availability of other investments.

These factors can all change suddenly and these changes can be triggered by a wide variety of events. These include recessions, pandemics, wars, government budget crises, financial system failures, or changes in monetary policy. It can also be a natural process for investors to learn about new technologies, such as the internet or blockchain.

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As a result, the market does not go up and down smoothly with corporate earnings. It moves through natural cycles that reflect the emotions and outlook of investors as a whole. We can be sure that the market will crash again, but we can’t always know exactly when.

Many investors have watched the damage done so far this year and they fear things will get worse from here. This is pure speculation as to what will happen next, but we can consider some important data points as clues. If we know what is most likely to happen in the stock market over the rest of the year, then we can prepare our investment plans accordingly.

Has the accident already happened?

The S&P500 is down more than 12% since the start of the year, while the NASDAQ has fallen 22%. A variety of things contributed to the decline. Rising interest rates, weak earnings outlook, geopolitical fallout from the conflict in Ukraine and worrying economic data all pushed the market lower. As a result, equities are firmly in correction territory and a bear market is in sight. People who were heavily biased towards growth stocks and the tech sector are already experiencing a bear market, although stocks as a whole aren’t there yet.

These dynamics all influence a larger overall trend. The market collapsed in the first quarter of 2020 in response to the COVID-19 pandemic. After this sharp decline, investors’ risk appetite rebounded on the back of low interest rates, fiscal stimulus and early signs that we were learning to deal with the global health crisis. Capital has flowed back into the stock market, particularly in growth stocks and companies that have not been disrupted by the pandemic.

These forces have propelled stock market valuations to levels not seen since the dotcom bubble. Stocks have become very expensive relative to expected dividends, book value, cash flow, sales and earnings. None of this was sustainable, and it had to eventually return to historically normal levels. Unfortunately, this reversal happened very quickly. High inflation forced the Fed to aggressively raise interest rates, which simultaneously made low-risk assets more attractive and threatened growth.

Although the market reacted to specific news, everything is happening within the general trend of valuations returning to normal levels. This is the most important thing that will determine if the crash is behind us – or if there is more to come.

Can the market go down even more?

Stock market valuations are much more rational than they were in December. This eliminated a lot of downside risk. However, there are still signs that things could get worse from here. Interest rates will continue to rise to fight inflation. The Fed may reverse its aggressive schedule if economic activity suffers too much, but rates are historically low – they will likely need to rise in the long run.

Economic activity appears to be slowing and GDP (gross domestic product) fell in the first quarter. In first-quarter earnings reports, many corporate management teams spoke cautiously about their outlook for the full year. Low unemployment and strong wage growth could falter, and any decline in the labor market will combine with high inflation to hurt consumer confidence.

Clearly, much of the fuel for this market downturn remains. Valuations are approaching pre-pandemic levels. Despite this, stocks are not cheap from a historical perspective. If stocks were incredibly cheap relative to earnings, cash flow, or dividends, that would create a floor for the market. Unfortunately, we are still well above this bottom if these macroeconomic conditions persist.

Nothing is guaranteed at this point, but a steeper crash is absolutely on the table. There are no clear stock market catalysts on the horizon, and current conditions are unlikely to be enough to prevent a bear market.

Investors should ensure their portfolio is allocated to withstand volatility, but it’s important not to panic and sell all of your stocks. There are still opportunities for long-term returns from here.

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