On Friday, the FTSE 100 index hit its 2021 intra-day high of 7,243.85 points, up 2% on the week. In the US, the S&P 500 closed at 4,471.37 points, also up 2% in a week and just 75 points (-1.6%) short of its record. Yet I still worry about the next stock market crash. When I get nervous, I seek comfort in the wise words of Warren Buffett. The billionaire investment guru warned in 1986: “Be fearful when others are greedy and be greedy only when others are fearful.” Here are four global issues that unnerve me right now.
1. US stock valuations
The returns from US stocks in recent years almost seem too good to be true. The S&P 500 index is up almost a fifth (+19.1%) in 2021, 28.3% over one year and 108.8% over five years (excluding dividends). In historical terms, these are truly extraordinary returns. However, sky-high valuations often precede a stock market crash. With the S&P 500 trading on 30.5 times earnings and an earnings yield of just 3.3%, I worry that US stocks are too pricey today.
2. ‘Sticky’ price and wage inflation
When I worry about the next stock market crash, I also feel uneasy about inflation. On Wednesday, we learnt that headline US inflation leapt 5.4% in the year to end-September, a 13-year high. In the UK, inflation for the year to end-August was 3.2%. This was the UK’s largest monthly increase since records began in 1997. Central bankers argue that elevated inflation is transitory, but I worry that a vicious circle of rising prices and wages could prolong inflation.
3. Tighter monetary policy
The best way to tackle inflation is for central banks to tighten monetary policy by reducing asset purchases (by buying fewer bonds) or raising interest rates. Already, the yield on the 10-year US Treasury bond has surged from below 1.2% in early August to 1.57% on Friday. This suggest that bond investors expect US interest rates to creep up. But if central banks do tighten policy, then this could damage global growth. And raising rates too far, too fast could ultimately trigger a stock market crash, as well as a bond meltdown.
4. Slower Chinese growth (property crash?)
Finally, my fourth worry is an economic slowdown in China, the world’s growth engine. Higher oil, coal and gas prices are pushing up input costs for Chinese factories. Also, supply shortages are holding back corporate recovery. On top of this, Evergrande — China’s most indebted property developer — is on the brink of debt default. If Evergrande does go down, then other developers will surely follow. Given that housing and construction account for 29% of China’s economic output, this sector’s setbacks could deliver bitter blows to global growth. With empty properties to house 90m people, China’s housing market could be heading for a crash in 2022.
Despite my worries of a stock market crash, I’ll keep on buying cheap UK shares. Why? Because I’ve seen four major market meltdowns in my 35 years as an investor and stocks have come back every time. Even the great crashes of 2000-03 and 2007-09 appear mere blips on a rising long-term trend line. What’s more, I see UK large-cap shares as among the cheapest assets in the world. As a bonus, they pay market-leading dividends to income-seeking investors like me. So when the next crash finally arrives, I’ll have cash sitting on the sidelines, ready to invest as share prices slide!