After the strong recovery of the last year, some investors now fear a stock market crash. Bubbles are blowing up everywhere. Bitcoin, Tesla, GameStop and a weird new asset class called non-fungible tokens (NFTs) have all triggered investor mania. Could shares be next?
Stock markets crash from time to time, it’s the price we pay for their superior long-term returns. This is nothing to be afraid of, I feel, as history shows they rebound over time. Here are three indicators that have predicted bubble trouble in the past. Where do they stand today?
Asset prices shoot up
Paul Jackson, global head of asset allocation research at Invesco, has looked at 15 historical bubbles and says they follow a broad pattern. Investors get excited by a new opportunity. Prices rise steadily, then skyrocket. The anticipated correction doesn’t come, triggering a final burst of euphoria. Then comes the stock market crash.
In a stock market crash, Jackson says share prices double or triple over two to three years, then spike by another 50% in the final months. This is the danger point. But I don’t actually think we’re there yet. Over three years, the world’s fast growing stock market, the S&P 500, has climbed from 2,721 to 4,194, a rise of 54%. Impressive, but not vertiginous. Year-to-date, it’s up a steady 13.3%.
Measured over three years, the FTSE 100 has actually fallen from 7,701 to 7,026, a drop of 8.7%. Nothing like a bubble at all. Year-to-date it’s up 8.7%. Again, that’s no bubble.
Cheap credit may cause a crash
Another common factor is that credit is easily available, encouraging investors to borrow to invest. Record low interest rates and unprecedented stimulus are definitely a cause for concern. Many now fear this could trigger inflation, which could crash the economy and the stock market.
At some point we will pay the price for cheap credit and stimulus, but I don’t think we’re there yet either. It’s not a healthy situation to be in, but nor is it the end of the world.
Stock market sceptics are converted
In the final stage of the bubble, Jackson says even the doubters give up and join in the mania. The herd instinct takes over, triggering a stampede to make quick money. We saw this in the recent Bitcoin crash.
We may see it in the next stock market crash too, but again, I don’t think it’s happening yet. Many investors remain sceptical. The euphoria has been confined to other asset classes, like crypto, or localised Reddit-fuelled frenzies such as GameStop.
I don’t see a stock market crash yet
The warning signs are there, but they aren’t all flashing red. Many top FTSE 100 stocks are trading at low valuations. As a long-term investor, I’m still investing in today’s market, but drip-feeding money in, rather than paying in large lump sums.
There’s another factor common to every bubble. Nobody knows when they will burst. If I hold off because I’m convinced the stock market will crash, the chances are I will never invest, and will lose out as a result.