Are we headed for a market crash?
Investing in the share market is not for the faint hearted.
When things are going badly and markets are falling, everyone looks for reasons why they should fall further or faster.
Nobody gets excited by falling prices being a buying signal, which they almost always are.
And when share prices are rising to new record levels – such as now – then the predictions of a looming market crash really start to take hold.
Market pundits fall over each other with predictions of doom and gloom to come as they all strive to be the one who is remembered for “predicting the crash’’ and the perpetual struggle between greed and fear carries on.
Filtering out the daily noise and gyrations
It is reasons such as this why many experienced investors talk about the importance of filtering out the noise of daily trading and market gyrations and step way back to monitor the longer-term trends.
Some even say you shouldn’t monitor portfolios daily, weekly or even monthly at all because seeing that information sucks you back into short term thinking and the temptation of rapidly switching between stocks.
The past week has been no exception with plenty of predictions of a looming market crash as the amazing January stocks rally lengthened.
Current market is crazy
Billionaire US investor Paul Tudor Jones was one of the many in the looming crash camp, saying that the current stock market was “crazy.”
“We are just again in this craziest monetary and fiscal mix in history. It’s so explosive. It defies imagination,” Jones said on CNBC’s “Squawk Box” from the World Economic Forum in Davos, Switzerland.
“It reminds me a lot of early ’99,’’ said Tudor Jones, referring to the then imminent dot-com bust.
Others have warned that the current market conditions are similar to January 2018, which led to a major market correction in February.
Some even call the current situation a stock market bubble which is sure to burst at some stage, while others are predicting a market correction, which would be healthy in the longer term.
Other analysts have dragged out the charts to prove that the last time such a high percentage of S&P 500 stocks were trading at these levels was January 2018, which led to a 10% fall over a few days in February.
Independent market analyst Mark Newton is another who sees striking similarities to January 2018 and thinks there are plenty of bearish indicators.
One is a growing gap between high yield US corporate bonds and investment-grade US corporate bonds and he claims there are other worrying short-term signs of investor exhaustion.
Traders are excessively optimistic
Another US indicator is the Ned Davis Trading Sentiment Composite which looks at whether traders are optimistic or pessimistic about the future.
At the moment that indicator shows that investors are “excessively optimistic” with a reading of 80 – the highest level the composite has hit since June 2018.
Over the past 14 years, the S&P 500 has shed an average of 5% each year following a reading over 62.5.
Predictions are unreliable
The problem with all of these predictions is that they are impossible to disprove.
All predictions are just that because actual market behaviour is dynamic and inherently unpredictable.
Market booms can continue for much longer than people expect and the same for market declines, so reacting to predictions makes for a very skittish and unreliable approach to investment.
Not everyone is in the bearish camp though, predicting an imminent crash.
Not everyone is turning bearish
Responding to the many warnings of an imminent crash analysts from JP Morgan Chase calculated that the S&P 500 would need to make its way above 3,700 to put the stock market at risk.
Their argument is that while the market performance from 2017-2019 resembles that of a bubble, 2020 would need to produce a year-long surge to produce a true market bubble.
It certainly started out that way by adding 100 points in January – which is a traditional investment month in the US – but is already moderating a little at the end of the month and is unlikely to keep pushing into that bubble territory by rising so rapidly for the rest of the year.
Investor Mark Cuban, who is famous for selling sold Broadcast.com to Yahoo in April 1999 for US$5.7 billion and also for owning the NBA’s Dallas Mavericks, is one person who is highly familiar with the dot com bust who disagrees that the current market is similar to that time.
Interest rates very different now
“Interest rates were a lot different back then,” Cuban said on a CNBC broadcast.
“And you saw a lot more people participating in the market. You don’t see that now. That individual day trading really led the market to be frothy.”
He said the levels of day trading have receded and given way to the rise of index funds, creating a very different landscape.
“There’s so much money chasing index funds, so as long as those funds keep on growing the market is going to go up,” said Cuban.
The other fundamental factor that can push markets higher or cause them to fall is profits.
The US earnings reports have so far been quite strong and in turn that has pushed the Australian market higher.
If profits can continue to rise and interest rates remain extremely low, it is only logical that shares will rise.
However, if those two indicators reverse and interest rates begin to rise and profits start to fall, that would be a real warning that share markets could not keep growing.
As Mark Cuban notes, with interest rates this low, “Where else are you going to put your money?”
“That money is going to continue to flow into our equities, our market,” said Cuban.
“I think interest rates will tell us what’s going to happen next in the market,” said Cuban, saying the market may appear frothy but it is not like it was just before the dot com bust.