This Is Why a Stock Market Crash Could Be Ahead
Warning: Don’t get too complacent with soaring key stock indices. A stock market crash remains a possibility for 2018.
There are three things investors need to keep in mind in 2018: stock buybacks, investor euphoria, and price escalation.
S&P 500 Companies Buy Immense Amounts of Their Own Shares
You see, over the past few years, there has been an invisible hand that has been supporting the stock markets: stock buybacks by the companies on the key stock indices.
Thanks to low interest rates, companies were able to borrow money and buy their own stocks.
Consider this, for example: Between the second quarter of 2012 and the second quarter of 2017, S&P 500 companies spent a little over $2.7 trillion on buybacks. (Source: “S&P 500 Stock Buybacks,” S&P Dow Jones Indices, last accessed January 9, 2018.)
The trillion figure is not a misprint.
How significant is $2.7 trillion? This is similar to the gross domestic product (GDP) of the United Kingdom!
Now, interest rates are increasing. Will the companies continue to buy their own stocks like they have been over the past five years or so? It wouldn’t be shocking if companies reduce their spending on buybacks.
With all this said, remember that, if stock buybacks decline, major buyers will suddenly be out of the market. This could make a lot of investors worried and we could see losses.
Investors’ Euphoria Continues to Soar
As markets continue to soar, investor euphoria keeps on climbing. Mind you, euphoria is one of the best indicators of an upcoming stock market crash.
Just look at the chart below. It plots the percentage of bullish respondents from the American Association of Individual Investors’ Investor Sentiment Survey.
Chart courtesy of StockCharts.com
In the last decade, investors have never been as bullish on stocks as they are now. In the most recent survey, 59.8% of all respondents said they were bullish on the stock market. The last time this figure was this high was back in 2003.
Extreme Price Escalation on Key Stock Indices
Look at the price action on the markets, too. We are seeing them increase way too quickly. This has been mentioned here before: it’s usually the last phase of the bull market when there’s a rapid move to the upside.
Consider the Dow Jones Industrial Average chart below:
Chart courtesy of StockCharts.com
There are two things to notice here.
First, the trend on the Dow between 2009 and 2016 was very gradual. Since early 2016, it has just taken off. The index increased 9,000 points between 2016 and now—an extremely quick rise relative to historical performance.
Second, between January 2016 and December 2017, there were only four months when the Dow Jones Industrial Average declined. This says there’s really no resistance.
What’s Ahead for the Stock Market?
I completely understand that any talk of a stock market crash at this point, when key stock indices are soaring, sounds outright irrational. But, as I said earlier, don’t get too complacent.
Dear reader, I continue to ask one question: Could the Dow Jones Industrial Average double in the next eight years? Sadly, I don’t see it happening. Before there’s a massive rally, we could see a stock market crash.
As I see it, this is not the time to get bullish on stocks. Rather, it’s time to get cautious, step back a little, and reflect on what is happening.