This Is Why the Next Stock Market Crash Could Be Huge
Mark these words, if there’s a stock market crash, it could be the mother of all crashes. It could be something like we have never seen before.
Why could this be?
Before going into any details, it’s important to understand how investor psychology works…
Investors, at times, tend to take profits to lock in gains. If a large number of them do it at the same time, prices start to slide quickly.
Then, if the selling continues, panic strikes. Those who bought recently start to question future returns, and the snowball effect comes into play—everyone starts selling and losses just continue to mount higher.
The price only finds support when there’s a major buyer in the market or there’s something that boosts investors’ confidence.
Now, going back to the next stock market crash…
Since the bottom in 2009, the stock markets have seen a massive move to the upside. In fact, it has been one of the best and longest bull markets in recent history.
Investors Have Accumulated Immense Gains Since the Last Crash
In the midst of this, Americans have made a lot of money since the last stock market crash.
Look at the chart below to get perspective; it essentially shows stock ownership of U.S. household and nonprofit organizations.
(Source: “Households and nonprofit organizations; corporate equities; asset, Level,” Federal Reserve Bank of St. Louis, last accessed January 30, 2018.)
Their wealth in stocks has increased from around $4.79 trillion in 2009 to $17.28 trillion. This represents an increase of over 260%.
What Happens Next?
Now, it has to be questioned, what happens next? Could the stock market continue like this forever?
As markets are near their all-time highs, we see the valuations getting more expensive by each passing day. For example, look at the CAPE ratio. It’s the price-to-earnings ratio of the stock market adjusted for cyclicality and inflation. This ratio currently stands at the highest level since the tech bubble, and severely above its historical average.
What’s also interesting to note here is that cash balances in investor accounts are at historically low levels as well. Their exposure to stocks is extremely high. We have heard all about this from brokers like TD Ameritrade Holding Corp. (NASDAQ:AMTD) and Charles Schwab Corporation (NYSE:SCHW). (Source: “Retail investor exposure to stock market is at an all-time high: TD Ameritrade,” MarketWatch, January 8, 2018.)
Let’s say investors start paying attention to valuations and try to raise some cash in their portfolio. Isn’t it a possible scenario that they might look to take some profits off the table?
Dear reader, there’s a lot more money at stake in the stock market than before.
Just before the stock market crash of 2008-2009, Americans had around $10.0 trillion in equities. Now, this figure is 70% higher.
If investors start to sell to take profits or just raise cash for their portfolio, it wouldn’t be shocking to see profit-making turning into panic, and panic into a major stock market crash. With so much money on the line this time around, it wouldn’t be surprising to see losses get much bigger. This could be the reason why the next stock market crash could be the mother of all crashes.