With the first quarter nearly over, it’s been a steady start to 2021 for shareholders. The FTSE 100 ended 2020 at 6,460.52 points and currently hovers around 6,749.04, up almost 290 points in 2021. That’s +4.5% in three months, which is a decent enough return. Meanwhile, the US S&P 500 index has risen from 3,756.07 points to 3,971.09, a gain of 215 points. That’s an uplift of 5.7%, narrowly beating the Footsie. Despite these rises, some investors fear a coming stock market crash. Should I heed these concerns?
The bond market gets trashed
One argument against a stock market crash is that bond yields were at all-time lows (because bond prices were at record highs). Or they were, until US Treasuries (USTs) — at $21trn, the world’s largest bond market — crashed spectacularly this quarter. At the end of 2019, the 10-year UST bond yield was 1.92% a year. During the Covid-19 crisis, buying demand for ultra-safe USTs pushed this yield to a record low of 0.52% in August 2020. Seven months on, this yield hit 1.77% this morning, its highest since January 2020. As result, UST prices have plunged, delivering the worst quarterly returns (-15%) for holders of long-dated USTs since perhaps the early 1970s. That’s 50 years. Yikes.
Why should shareholders worry about bond prices when weighing up the odds of a stock market crash? Because USTs are regarded the world’s safest asset, producing the ‘risk-free rate’ from which many other assets are priced. As UST yields rise, they become relatively more attractive, reducing the allure of riskier assets, including stocks. Since August, UST bond prices have given back nearly all of their gains from 2020.
Jerome Powell, chairman of the Federal Reserve (the US central bank), recently indicated that he didn’t expect to raise interest rates before 2024. Alas, with UST prices crashing since August, the market is raising interest rates for the Fed. Bondholders are worried about the risk of rising inflation (higher consumer prices) undermining the value of their fixed-income bond coupons (interest payments). Furthermore, thanks to the pandemic, the world is awash with vastly more government and corporate debt — tens of trillions of dollars of it, in fact. With the bond market crashing, it’s possible that this might spill over, triggering a stock market crash.
Why I don’t fear a stock market crash
As it happens, I’m not afraid of share prices tumbling in a stock market crash. For bond prices to keep falling (and bond yields to keep rising), we’d need to see more concrete evidence of rising inflation and wage growth. But if inflation takes off, the driver will be rapid economic recovery and rising consumer demand in any post-Covid-19 recovery. In a brighter economic environment, I’d expect company earnings to bounce back strongly from 2020’s lower levels. In other words, if inflation forecasts keep getting upgraded, it’s likely that growth predictions will also follow suit. Indeed, the International Monetary Fund expects global growth of 5.5% next year, one of the strong performances since the 1970s. Wahey!
Of course, falling share prices are good news for investors like me who plan to buy more stocks to increase my shareholdings. In the previous stock market crashes of 2000-03 and 2007-09, I made good money simply through buying shares in quality companies at bargain-basement prices. Hence, if the UK and US stock markets do tank, then I’ll don my buying hat once again and wade in deep!