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Have you heard people speak about a crash in the stock market? Yes, such a market does undergo a crash – a sudden rapid, and often unexpected drop in stock prices. The scenario may be a side effect of an economic crisis, a catastrophic event, or even public reactions that induce panic selling. It has occurred severally in the past, with the biggest one in 1987.
However, is the stock market crash coming anytime soon? What are analysts saying? Most top investors and analysts have indicated that there are prospects of that happening. But, how do we know if a stock market will crash?
Potential Reasons for a Crashing Stock Market
Several reasons or factors can play a role in a crashing market depending on when it happens. In this COVID-19 pandemic, different factors can cause the stock market to be chaotic with high volatility rates. Here are some of the reasons that may cause the stock market to crash in the coming months:
• High Inflation
There has been an increase in inflation, especially since the Federal government provided stimulus payments for its citizens. The Consumer Price Index for all urban consumers increased by 6.2%. People have had much cash in their pockets to buy food and other basics, leading to above-average food inflation.
• Fed Reserve Action
This could also cause the stock market to crash over the next three months. The interest rates of the country’s central bank have been kept low for many years allowing for stock growth.
Fed has also been fairly aggressive in buying long-term Treasury bonds and mortgage-backed securities to promote lending and confidence in the housing market. However, with the increasing inflation, the Fed has no choice but to raise interest rates and begin minimizing its bond-buying program, resulting in a huge drop in stock prices.
• Margin Debt
Margin debt is money that people borrow from a broker with interest to buy or short-sell securities. While it can increase an investor’s gain, it can also lead to rapid losses. Seeing the nominal outstanding margin debt grow over time is normal, but the rate at which it increased in 2022 was alarming.
It rocketed higher by over 70% at the beginning of that year and was greater than in 2020. Since 1995, the margin has surged past 60% in one year in only three instances – meaning that the one in 2021 was higher and didn’t sound well for the stock market.
• The Omicron Variant Speed
2021 saw the S & P 500 enjoying over five dozen record-high closes, especially because of the increased U.S. and global vaccination rates that made business get back to normal.
However, with the new Omicron variant, the possibilities of further lockdowns, restrictions, and a possible decrease in consumer spending are looming and imminent. Like the delta variant, which led to a short-term market hiccup in May last year, the Omicron variant could cause a similar issue and lead to a market crash.
• Energy Price Indigestion
If the price of crude oil increases in the next few months, consumers and businesses will purchase less fuel or pass higher fuel costs to consumers. In whichever circumstance, the oil market should provide some level of stability over the coming months. If the price per-barrel rise above $80, inflation fears could dominate, while if it falls below $50, investments in all sectors could be curtailed.
• Sector Rotation
It’s a state whereby investors move money from one sector to another. If that happens, the stock market could dive. It wouldn’t be strange to see investors locking in some gains on companies with valuation premiums and moving some of their cash to safer investments and dividend plays with value. If they choose to do that over growth stocks, the stock market will be under serious pressure.
• Meme-stock Trade Reversion
This is another potential for a stock market crash. Each year, the Federal Reserve releases its Financial Stability Report twice – the report examines the country’s financial system resilience and highlights some of the larger near-term and longer-term risks worth scrutinizing. The latest report by the central bank outlined the possibility of young investors putting their money to invest in meme stocks like GameStop and AMC Entertainment which could accelerate volatility and disrupt the market.
Yes, several reasons point to a near-future market crash, possibly in the next three months. Remember that if a stock market crash occurs, it would be a fantastic buying opportunity for long-term investors. What if you’re into stock market investment? How can you prepare for a coming crash? Here are some suggestions to prepare your portfolio for the crash: –
• Have a Plan
A well-established plan will help you bounce back and expand well in time from a crash. So, stay put and avoid being panicky. Despite three major crashes between 2000 and 2020, those who hung onto their investments and had a plan came out way ahead of others.
• Diversify Properly
Learn to diversify your portfolio; a rise or stability of another may offset one sector’s drop. Therefore, allocate your assets and resources carefully. Try investing in bonds, fixed income, and cash. Even if the stock market crashes, you’ll have other assets to lay your hands on.
• Know the role of bonds
Bonds have done fairly well since 1980 because interest rates were decreasing and moving in the opposite direction from bond prices. While the rates may be currently rising, after some time, bonds will likely help you supersede inflation, with some price appreciation thrown in. A decent dollop of bonds may be necessary when stocks dive.
• Get help
Everyone’s circumstances vary in the stock market. You might not know all things; thus, it pays to seek assistance from experts like financial advisors to crunch the numbers for you. They can offer tailored in-person advice and also help you fortify your portfolio.
The Bottom Line
2021 ended with a superb performance report card of an economy stabilizing. However, much of 2022’s performance depends on all the factors none can correctly predict right now. Numerous factors point to a crashing market, with inflation being key. Maybe by June, we should know the inflation level, which will set the pace for the remaining half of the year. Meanwhile, we have to keep moving, but shrewdly!!