As the 30-year anniversary of Black Monday approaches, it might seem like there are a lot of ads and articles suggesting that the stock market is going to crash.
Actually, these so-called prognostications are ubiquitous: during bull markets, someone is always ready to call the top of the market. And during bear markets, people try to pinpoint the bottom.
But if you sell before the market reaches a pinnacle, you get to watch stocks continue to go up. You might regret selling too soon and want to get back into the market. Don’t do it — that’s buying at a high, and you’ll regret that even more when the market goes back down.
Why Is the Stock Market Going to Crash?
An experienced investor is wise to question the motives of all those who announce to the world that the market’s about to go down: Does they benefit from encouraging you to sell your stock?
When everyone else sells high, that puts downward pressure on stock prices — which in turn benefits short sellers, or those betting that stock prices are going down.
Use this same logic during bear markets: What’s in it for the pundit who suggests that now’s the time to buy low?
Except that none of it is that blatant. Overtly telling the public it’s a good time to sell when you’re hoping to buy — and vice versa — gets people into the crosshairs of the Securities Exchange Commission.
So the pundits either put the word out indirectly — like by talking to the press — or they do it in language that’s about as specific as a horoscope. The time horizon might be within a year, and no individual stocks are named, but the stuff’s going down.
Crash Versus Correction
No one is saying you should distrust any warning about a possible decline in the market. Eventually, bull markets end — so do bear markets, for that matter.
Instead, realize that an all-out crash simply cannot happen as quickly as it used to, and a much more gradual or modest downturn is far more likely.
Technology implemented after the crash of 1987 has scaled back the amount of market carnage that can occur in a single day: Circuit breakers on exchanges work like the master switch on electrical current in your home.
Chill for 15 Minutes
Here’s how it works on the New York Stock Exchange. If a stock’s price drops 7% or more within a day, trading stops for 15 minutes.
If, after trading resumes, the stock descends to a 13% drop for the day, another 15 minute halt kicks in.
If after the first two halts, the stock continues to drop to reach a 20% decline, trading in that equity stops for the rest of the day.
If any of these thresholds are reached during the final hour the market is open, trading halts for the rest of the day.
These halts neither stop nor prevent a stock from descending — it just happens more gradually, over the course of days or much longer periods of time.
Even in the shorter term, a trading halt on one exchange doesn’t initiate halts on other exchanges at the same time — nor does this put a stop to after-hours trading.
However, the circuit breakers do force traders to take a break and think things over. Slowing the momentum of a descent can reduce risk.
Healthy for the Market
Is it a coincidence that as the anniversaries of both the 1929 and 1987 stock market crashes approach, there seem to be a lot of warnings about a market correction?[/caption]
Slowing down the momentum of a price’s movement can be healthy for the market because that effectively prevents bigger, deeper downturns from happening.
That’s why the term “correction” is used — it refers to a 10% slide in stock price compared to its high price for the year. A correction happens much more gradually than a crash (which is usually construed as happening within a day).
Corrections also happen more frequently — an average of about once a year, according to Deutsche Bank.
They last an average of 14 weeks, and apparently analyts are unable to predict the immediate cause of a correction before it happens. In general, the causes of stock price movements become known in hindsight.
More importantly, downturns that last only 14 weeks are generally more of a concern for investors with short-term goal horizons. Corrections do, however, provide opportunities to find relative bargains in stock prices for buying low.
But making too many moves into and out of stocks has become more difficult for those who do not qualify as professional investors. The pros have faster trading platforms and use algorithms to more rapidly than consumers can keep up with.
If You Can’t Stomach a Decline
If you find the prospect of a 10% decline in stock prices is more than you could bear, that could mean your appetite for risk might be on the moderate or conservative side of things.
Both entail reallocating an investment portfolio to include more fixed income, including bond funds.
Depending on what your investment time horizon is, if you had a moderate risk tolerance, you might opt for about 65% in stocks (or stock funds), 30% in bonds (or bonds) and 5% in money market funds or cash.
A conservative portfolio might shuffle that ratio to 25% stocks (or stock funds), 45% bonds (or bond funds), and 30% in money markets or cash, again depending on the time horizon.
Large Cap and Dividend Paying Stocks
The stock portion of both the moderate and conservative portfolio would have predominantly large-capitalization and dividend-paying stocks, with modest proportions of smaller-cap and foreign stocks.
The bond portions of these portfolios could include a mix of high-yield corporate bonds, foreign bonds, and government bonds — with the moderate strategy including more high-yield bonds.
If the stock market were actually going to crash within a year — that’s the time frame ususally invoked in the ads — even aggressive investors would do well to scale back to something more moderate.
But knowing that a literal crash can’t happen as briskly as it did three decades ago — let alone 88 years ago — should hopefully help you stay relaxed in the face of bear market hyperbole. After all, the experts say it’s best to keep emotions from influencing one’s investing decisions.
Readers, have you been worried about when the stock market might move down?