We get this question often these days and a quick Google search of the question “will the stock market crash” provided 416 million results in ½ second. It seems to be a popular question. The short answer is “I don’t know, and no one knows.” Sorry to burst your bubble if you thought I had the answer.
However, there are many pundits, prophets, and prognosticators (and charlatans and soothsayers) who are not shy about proclaiming the next stock market crash is imminent. One so-called expert wrote in July a stock market crash is likely within three months and it will be the biggest crash of our lifetime. Even an article on The Motley Fool website (which is generally pretty optimistic) proclaimed a stock market crash could be here soon.
What is a Stock Market Crash?
What do we mean by a stock market crash? It depends on who you ask, but in general, a stock market correction is a 10% drop from a high point. Using the S&P 500 Index as a proxy for the U.S. stock market, the all-time high was 4,536.95 reached at the close of business on Thursday September 2. Therefore, a 10% correction would mean this index would have to fall (453.6 points) to 4,083.25. Most people would not call that a “crash.” It might make some investor uncomfortable, but because the S&P 500 Index has increased about 20% in 2021, it would not be a big drop and many investors would shrug it off.
A 20% downturn in the S&P 500 would probably not be considered a “crash” either. A 20% correction is called a “bear market” if you see that term. As I noted above, a drop of this amount now would simply put the S&P 500 Index back to where it was at the start of 2021. Again, not a comfortable thing, but not the end of an investor’s world.
How about a 30% drop in the value of the S&P 500 (1,814,78 points) from its all-time high? Would that qualify as a crash? In most investors’ minds, I think it would. Look at this chart of the closing prices of S&P 500 index:
On January 4, 2018, the S&P 500 closed at 2,733.99. This is where a 30% drop in the S&P 500 Index from today would take us. This kind of drop would make most investors nervous. (Note the two big dips at the end of 2018 and in early 2020. Do you remember how you felt and what action, if any, you took then?) Consequently, if the S&P 500 closed around 2,700 this year or in 2022, it would make most investors nervous or worse, panicked.
Stock Market Correction Happen Often, Crashes Not So Much
According to an article on the Motley Fool website that cites research from Yardeni Research, a 10% stock market correction occurs on average once every 1.87 years. Note I said on average. There have been several five-year periods when one didn’t occur. However, this suggests corrections occur with regularity.
On the other hand, a stock market drop of 20% happens less frequently. Since 1960, there have been eight 20% or more corrections according to the Motley Fool article (an average of once every 7.5 years). This is one reason many investors expect a correction to occur sometime soon – it’s been about 18 months since our last correction. As a result, some investors believe we’re due for a stock market drop just on this fact alone.
Reminder: The Future is Un-Knowable!
Here’s the first point I want to make. In October 2018 and February 2020, no on knew a market correction (in October 2018) or crash in 2020 was about to occur. No one can know when a market correction or crash is about to occur.
Why Ask the Question?
Why then do so many people seem to be asking the question, “Is the stock market going to crash”? I believe there are several reasons tied to basic human nature and the abundance of information.
Reason #1: People don’t like un-certainty because it makes them feel out of control. When the first cave dwellers learned to communicate, after asking “where’s the beef (or mastodon)?” the question they asked one another was “what’s going to happen when the sun comes up again?” In the cave dwellers world, food gathering and hunting were critical tasks and it was hard to pick berries if there was snow on the ground or too much rain.
We’re still like that. We all tune into the weather channel to see what kind of day we’re going to have tomorrow. Not because we need to pick berries or hunt for dinner, but because we want to know if we can plan outdoor activities. And the same wanting to know what the future holds is a theme for just about every aspect of life. Who’s going to win the Super Bowl, who is going to be the President, what colors are in, when will my package arrive, what will be winning lottery numbers, when will our house sell? They’re all questions about the future and are all aimed at giving us control or being prepared for the future.
Take this fondness (obsession?) for wanting to know the future into the investment markets and, what do you know, you have active investing, CNBC, and stock market gurus all trying to predict the future. It’s a great way to make money because it taps into the basic human desire to have control. Ask a cave dweller how that worked out for them. I’ll bet no one saw the ice age coming.
Reason #2: FOMO (fear of missing out). Let’s go back to our cave dwellers. To survive, cave dwellers needed one another. A solitary berry picker had less chance of finding the good raspberry patches. A solitary hunter had less chance of finding rabbits, buffalo or whatever he was hunting, and he couldn’t bring down a large prey by himself. Thus, to survive, FOMO was born.
The same holds true today. No investor wants to be left behind when she/he thinks they could have followed the herd and either bought the next big thing or avoided a big loss. Fads have existed since the Dutch tulip bulb mania of the 1630’s and up to the current manias of sports cards, crypto currencies and meme stocks. Manias are largely based on FOMO and the greater fool theory. (From Investopedia: The greater fool theory argues that prices go up because people are able to sell overpriced securities to a “greater fool,” whether or not they are overvalued.)
Reason #3: Too much information. The information cycle is now 24/7 and intense. My wife was listening to the NBC Evening News yesterday and I was not watching but could hear the preview. I was struck by two things: (1) how many negative stories were highlighted and (2) the urgent, strident tone of the announcer. Just listening to the preview of the news I was depressed and assured the world is about to end. And that’s the evening news. Multiply this by the number of investment articles, website, chat rooms and even NPR and the poor investor is overwhelmed by bad news.
I’m not saying there aren’t tragic stories out there. Of course there are. However, the information to which the average investor is exposed is mostly bad news and there is good news too. COVID-19 leads the bad news pack right now, of course, and then comes unemployment and inflation. On the other hand, we have vaccinations, industries are re-opening (dining, travel, and entertainment) and low interest rates. However, good news doesn’t sell nearly as well as bad news.
It takes a strong mindset to weigh the good and bad news and have perspective.
What To Do Now
“We can run numbers and make predictions all day long, but at the end of the day, we have no idea what’s going to happen for the rest of 2021—no one does. So let’s be the kind of people who are prepared for anything the future has in store.”
On a practical level, here are our suggestions for what to do with your investment portfolio:
- If you’re within five years of needing money from your portfolio, it should be invested to protect the principal. For example, if you’re within five years of retirement, a 50% stock/50% fixed income portfolio is more appropriate than a 70/30 or 80/20 mix. Yes, you might give up the potential for some gains, but you will be better prepared to weather a downturn (and probably sleep better at night).
- Have patience, perspective and be persistence. If the stock market goes down – even a lot –be patient and wait for it come back up. Keep saving if you’re in that mode. You might be buying stocks on sale!
- Rebalance your portfolio to your target asset allocation. The run-up in stocks this year might have un-balanced your portfolio. The intelligent investor rebalances when her/his portfolio gets out of alignment. It takes courage to sell assets that have gone up, but you must maintain the right portfolio mix or you might be un-pleasantly surprised if there is a large stock market downturn.
- Limit your access to news media, especially the financial pornography that is disguised as investment market news. All the ads and many of the “experts” on CNBC, MSNBC, the Wall Street Journal, most podcasts, and investment newsletters have one goal in mind – to separate you from your money. Ignore them and concentrate on item #5.
- Focus on the things you can control – your spending rate, your savings rate, the quality of your work, the quality of your relationships, and your overall physical health.
Will a stock market crash start tomorrow or the next day (or has it already begun)? I don’t know and no one else does either. Instead of worrying about it, do the five items mentioned above and go have some fun. Maybe pick some berries or have a Mastodon burger.
Or, if you’d like to discuss your portfolio strategy with one of our fee-only and fiduciary financial advisors, click the “make an appointment” button on our website. We’re happy to discuss your personal financial situation on a free Get Acquainted session.