3 reasons why a stock market crash could be coming
Stock market crashes are not new to individuals who have recently started investing. Pretty recently, there was a market crash triggered by the Covid-19 pandemic. Between 12 February and 23 March 2020, the Dow Jones lost about 37% of its value as economies went into lockdown. The Dow lost nearly 3,000 points or 12.9% of its price on 16 March alone.
The stock market, like many other things in life, has its ups and downs. There are bubbles, bull markets, bear markets, retracements and sometimes, although less often, a crash. Typically, prices usually recover within 18 months, which creates plenty of buying opportunities for my portfolio. So, is there another market crash on the horizon? Let’s take a look at what I think could be the three most likely triggers.
What is a stock market crash?
A stock market crash refers to a sudden drop in stock prices which can lead to substantial losses by investors. The fall is usually measured by the direction of indices. This has happened several times over the years. The first major crash was experienced in 1907, another in 1987, 2008-2009 and recently in 2020. And I can say with confidence another one is inevitable over the long term. That being said, here are three reasons why I think a stock market crash could be on its way.
#1 Increase in retail investing
Over the past few years, there has been an exponential increase in retail investing. Just this year, a massive flock of young investors entered the stock market, the vast majority of whom were amateurs with highly speculative strategies.
The height of this was seen in the meme stock movement that continues today, where a collection of mostly struggling businesses saw their share prices explode to unsustainable levels. GameStop and AMC Entertainment are prime examples of this despite both firms being in significantly weakened financial states. Needless to say, this isn’t sustainable over the long term. And suppose shares being inflated in such a fashion fail to meet the extraordinarily high expectations from investors. In that case, these stocks could very quickly come crashing down, which, in turn, could trigger a stock market crash.
#2 Cryptocurrency burst effects
Cryptocurrencies are gradually gaining ground in mainstream finance. That notwithstanding, these digital assets remain highly speculative. Yet that hasn’t stopped some businesses, like Square, from dipping their toes into the space.
Earlier this year, China’s ban on cryptocurrencies sparked a lot of regulatory concerns, even in the US. Although prices have recovered their lost ground, it may not last over the long term if strict regulatory oversight is introduced. Just recently, the US Treasury concluded that Stablecoins issuers – cryptocurrency tokens designed to mimic the price of a fiat currency like the US Dollar – should be regulated like a depository bank. That’s an exceptionally high level of regulation that could decimate this segment of the cryptocurrency space. And at the same time, set a precedent to introduce similar regulations in other areas of this space.
In this scenario, cryptocurrency prices could plummet, taking down any company invested in the space with it. And potentially lead to a stock market crash as a consequence.
#3 Possible hike in interest rate.
Interest rates were cut to their lowest point at the start of the pandemic. But due to the vast amount of stimulus being injected into economies worldwide, fears of inflation are on the rise. And if these fears turn into reality, interest rates may have to climb to counter rising inflation.
That’s good news for bondholders. But for the stock market, it could cause a severe correction or even a market crash as business’s see their interest bills on loans jump. And for the companies with enormous piles of debt, it could even lead to bankruptcy.
Final thoughts on a potential stock market crash
It’s exceptionally difficult to accurately predict when a stock market crash will occur. But a common trigger is prices being inflated to unsustainable levels. A prime example is the dotCom companies in the late 90s or absurdly high property prices in 2007.
Today it seems similar levels of price inflation is being triggered by several factors. But predicting when or even if this suspected bubble will burst is anyone’s best guess. Regardless, suppose a stock market crash does come. In that case, I’ll be ready and waiting to buy shares in strong businesses selling at a discount for my portfolio.
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Prosper Ambaka does not own shares in any of the companies mentioned. The Money Cog has no position in any of the companies mentioned at the time of writing. Views expressed on the companies and assets mentioned in this article are those of the writer and, therefore, may differ from the opinions of analysts in The Money Cog Premium services.