Many discussions are bouncing about the headline- Will the next stock market crash be in 2021? Many big analysts, forums, and even big-shot investors like Warren Buffet are expressing their views on this.
With all that has been happening all around the world for the past 1 year, it is understandable why this question has been raised.
If you are also curious, then keep reading and build up your own opinion about this and discuss it with your peers.
What is a Market Crash?
The term “market crash” holds such seriousness that even individuals who have not have much knowledge about the stock market and how it works, also know that things will not look good if such an event occurs.
So, for all the folks who have less knowledge but plenty of curiosity about this term, let’s start with the basic meaning. In layman’s terms- a stock market crashes when stock prices start dropping to new lows. The reasons for this sudden price drop can be plenty.
To state a few, it can be due to an economic crisis, a major fateful event, or the bursting of a speculative bubble, like the housing bubble in the 2008 crisis. Even sometimes prior anticipation of a market crash can cause it.
Because, investors will start panic selling their stock, leading to a dramatic fall in the stock prices.
Thus, not only economic and societal crises but also psychological behavior such as herd behavior, fear, and panic can also result in the market crashing.
Some of the worst stock market crashes are the stock market crash of 1929 (The Great Depression), Black Monday in 1987, Black Friday in 1869, the Financial Crisis in 2008, etc. All these crashes had different reasons but led to the plummeting price of the stock.
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Indicators of a Possible Future Market Crash
It is better to be prepared beforehand than to face a crisis head first. Many analysts use multiple factors to predict the onset of a market crash.
No matter how serious an event or incident is, it will not affect the stock market negatively in a single night. The most evident indicators that every analyst or savvy investor looks out for are:
Overvalued
Even the stocks of good companies, if overvalued, will see a downfall. Say, for example, a company’s stock value, on average and based on historical data, has been 12 times EBIT, but currently, it is being traded at 23 times EBIT.
There is a fair chance that the value of the company’s stock will start declining.
Excessive Speculations
This factor has been an indicator for many of the past market crashes. Speculative trading is always related to higher risk. Thus, if the investor’s speculation is right they earn plenty of profits but if something goes wrong then they will face a huge loss.
Now, this was about a single speculator, say many savvy investors that part in speculative trading.
This will create a speculative bubble and this formation of the bubble is the first indicator that the market is on the path of crashing. And when this bubble “bursts”, there is a very low chance of any kind of recovery of the invested fund.
Low-Interest Rate
The principal reason for the creation of bubbles is too much money in the market. When central banks encourage the banks to lower the interest rates using the fractional reserve lending mechanism, this creates more money in the market.
There is a heated investment in assets like stocks and real estate thus, creating a bubble in these asset classes.
With time, the central bank will raise the interest rate to control inflation, and this is when the price of these assets starts falling as the money gets sucked out of the market.
Therefore, investors when seeing that the interest rates have been low for quite a noticeable period, become more aware as probably a bubble is already forming.
Low Growth Rates
Low growth rates mean slow economic growth. But this indicator alone cannot be a strong hint to the market crashing. But, when paired with an indicator such as excessive speculation, this sends off warning signs.
If the indicators of a slow growth rate such as GDP, inflation, and unemployment are showing slow economic growth whereas the market is booming, then this is an abnormality. And abnormal events are fleeting.
Thus, very soon the market will also start falling just like the economy. Therefore, informative investors will start liquidating their holdings, and prices will start dropping further.
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Tips to be Prepared for a Market Crash
Just knowing the indicators is not enough, you need to use them and plan so that you have a safety net in case the market crashes.
Focus on diversification and quality
Having a diversified portfolio is always a good way to reduce investment risks. Identify the bear and bull sectors and change the weightage accordingly to avoid any sudden losses.
Also, do not blindly invest in bonds. Check to see their grade. Even if investment-grade bonds feel “boring” in comparison to high-yield junk bonds, they promise fewer losses and secured returns.
Have cash in hand
This cash is not for overcoming the losses but to take advantage of the bear market. As said before, even big companies suffer during crashes.
So what you can do is use the cash in hand to buy yourself ownership in these big companies at a much-discounted price.
Be cautious
Evaluate your risk tolerance and create a portfolio that will be able to absorb the losses.
In other words, if you are a long-term investor, then create a portfolio taking into consideration the possibility the value of the assets will fall 20 percent to 30 percent.
Conclusion
For the past year, the market has been very volatile, but that does not concrete the fact that the next crash will be in 2021.
Always remember that with the stock market, nothing is completely predictable. Look out for the indicators and invest cautiously.
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