Dear Financial Voice Reader
Is the US Stock Market Going to Crash?
Almost exactly a year ago I asked this question in this column. The question is more relevant than ever now.
Does the Buffet Indicator Suggest a Stock Market Crash?
The “Buffet Indicator” has long been known in Wall Street circles as a stock market valuation metric worth paying attention to. It’s a straightforward ratio that takes the total market capitalisation of U.S. stocks and divides this by the nation’s GDP. Even last February it was at 195%.
The PE ratio is the investment price divided by its profits or earnings. Because each year brings about its own ups and downs, the Shiller PE ratio — also known as the CAPE index — takes a long view and calculates the rate by earnings over the last decade, adjusted for inflation. The current Shiller PE rating suggests the US stock market has been this overvalued twice before: the 1929 stock market crash and the 90s Dot Com bubble.
What Could Cause the Crash?
While there are many ways a crash might happen, it would take a combination of a few events.
Continued COVID-19 Problems
Though things are looking positive, we’re not entirely out of the woods yet. The vaccine rollout has been encouraging, but further mutations or variants could render that mute. Were that the case, additional lockdown measures could push the economy to a breaking point.
The unprecedented stimulus packages were all that kept the market from destruction in 2020, and a failure to get this right during further waves would be catastrophic. However, all in all, this outcome is remote.
Loan and Credit Delinquencies
While the market has performed well since March, out on the ground things are far from normal. A series of loan, mortgage and credit delinquencies could hurt US financial stocks badly. And with government funds already being hoovered up by covid stimulus packages, the financial markets could find themselves unable to receive the assistance needed.
Shiller Is Right
If the Shiller index is correct — and the market is overvalued — that will hit at some point, and will lead to some panicked and erratic behaviour as consumer confidence evaporates. As long as the market continues to perform, people will ride the wave. But a few poor annual returns from tech stocks, in particular, could see sentiment change quickly and violently.
My conclusion is that quality companies with outstanding profits, growth, cash flow have fallen to now stabilise at a slower rate of share price growth. Poor quality companies often making losses and paying no dividends have generally fallen because sellers will remain sustained in them and their risk is clearer.
