Is The Stock Market Going To Crash?

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I recently received an email from a long-time reader that started with the following subject line:

Subject: We Are About To Crash Again

The email was basically asking “Is The Stock Market Going To Crash?”, and asked my thoughts on a YouTube video he had just watched which had concerned him.  I watched the video, emailed him my reply, and told him I’d write a post to address his questions in more detail.  This is that post.

Today, we'll watch a Doomsday video and address the issue of whether the stock market is going to crash. Click To Tweet

Is The Stock Market Going To Crash?

Retirement has a way of heightening anxiety, and concerns about “Is The Stock Market Going To Crash” seem to increase once the paycheck has stopped.  We’re at the point where we must pay for our living expenses via withdrawals from our portfolios and a stock market crash has the very real potential of impacting our lives.

So, if you’re looking for an executive summary, here it is:


Q:  Is The Stock Market Going To Crash?

A:  Yes.


There you have it.  No need to read any further. 

Glad to see you’re still with me.  Smiles.  The reality is that the market has always crashed, and it always will.  Type “history of stock market crashes” into Google, and you’ll get 10 Million results.  I found this summary from Wikipedia of interest, which shows a list of all the crashes since the 1637 Tulip Mania Bubble.

Regardless, things do seem especially volatile in this crazy year of 2020, so let’s dig a little deeper in our answer to the question “Is the stock market going to crash?”.  My friend’s email was triggered by watching this video (it’s 17 minutes long, so skip to my summary below if you’re short on time):

Summary of the Doomsday Video:

I’m not familiar with George Gammon, but he’s got 121k subscribers so I suspect he’s well known in the space.  I do like his “instructional” style, and his explanations are clear and easily understood.  In summary, his video presents a case that we’re currently in a stock market bubble and explains the various components which support his thesis that a market crash is imminent.  Below, I’ll summarize each of his main points, followed by my thoughts on each: 


1) Structure of a Bubble:  George explains the historical stock market pattern of moving through these phases: Stealth (undervalued) to Awareness (coming off the bottom) to Mania (over-valued) to Blow-off (capitulation and despair), summarized below:

My Thoughts:  While I agree with the general premise of market cycles, I urge caution in trying to “time the market”.  I’ve never met anyone who is successful in combining a “sell at the top” with a “buy at the bottom”.  If you only get one leg right, you’ll have regrets.  Better to have a strategy that doesn’t involve successfully timing the tops and bottoms.

My Recommended Approach: 

  1. Plan for the long term, and realize volatility is the price for the long term rewards offered by stocks. 
  2. Set an appropriate Asset Allocation, and be consistent in your rebalancing approach.  
  3. Keep a cash buffer to avoid selling during a bear.
  4. If you have a lump sum or cash to invest, consider dollar-cost averaging in over 12-18 months.

2. Components Of A Bubble: George comments on the following components of a bubble:

a. Leverage/Liquidity:  Today’s market has the highest margin/leverage in history, which George argues is important to understand when trying to answer “Is the stock market going to crash?”.  While I agree with the high leverage, it’s important to understand the implications of today’s historically low-interest rates and their impact on leverage economics.  George fails to discuss this when presenting leverage, which is an oversite in my opinion. Regarding liquidity, George argues that recent Fed stimulus has fueled demand for stocks, as many people invested their stimulus checks into the stock market.  I would argue this isn’t necessarily an indication of a “bubble” since we have no means of knowing how long those investors plan to hold the stocks they purchased.

b. Innovation:  George argues that bubbles in the market can develop when people have unrealistic expectations of the impact of innovation on future market conditions. Specifically, he cites 3 areas where innovation is being given too much credit:  1) The Fed’s ability to provide innovative market solutions, 2) excess money printing and 3) electric cars, with specific mention of Tesla being grossly over-valued (I agree with the Tesla view, for the record).

My Thoughts:  If we believe the market is efficient (which I do, for the most part), you could argue that the factors presented above are efficiently priced into the current market.  That said, I do remain skeptical of The Fed’s ability to continue to leverage quantitative easing and debt without detrimental long term effects (specifically, inflation and currency devaluation are two of my bigger concerns).  

My Recommended Approach:  I don’t see the points raised in this section as warranting the avoidance of stocks in your asset allocation, as I do have faith that the market will continue to offer the highest potential for long-term returns.  I do believe a wise investor should allocate some portion of their portfolio to “hedge”-type investments, including TIPS (inflation adjust bonds) and precious metals.  I target 10% of my asset allocation to “alternative” investments, which include REITs, precious metals, commodities, and options trading.  I’m also planning on delaying Social Security, primarily as an inflation/longevity hedge.  Having some portion of your assets that could offset future inflation seems to be a reasonable insurance policy in my view.


3. Psychology Of A Market Bubble:   George presents 5 aspects of psychology that are commonplace when the market is experiencing an unsustainable bubble, including:

a) Anchoring:  We tend to use the current market value as an “anchor” for future moves.  If it moves down, we assume it’s undervalued.  If it moves up, we feel it’s expensive.  Our perception is based purely on price, not valuation.

b) Hindsight Bias: We over-emphasize recent performance in our predictions of future performance. 

c) Confirmation Bias:  We seek out information that supports our existing theories, and ignore information that disputes our beliefs.  “Echo chamber” thinking.

d) Herd Behavior:  We mimic the action of a larger group, which can lead to self-reinforcing cycles of aggregate behavior.  George argues that this is the “core reason why asset bubbles exist”.

e) Overconfidence: We overestimate our intelligence and ability relative to others.

George argues that the combination of these psychological tendencies leads to a majority of people thinking “It’s different this time”, and lead to market corrections hurting the majority of people.  People tend to get lured in at the peak and sell at the bottom, based on these psychological tendencies.  George argues that since “the herd” is currently investing heavily in the market, it’s a warning sign when we’re attempting to answer the question “is the stock market going to crash?”.

My Thoughts:  While I agree with many of the psychological tendencies presented in the video, I don’t agree that they are current indicators that we’re on the cusp of a major crash.  I view the tendencies as fairly generic and ever-present rather than being significantly different than they’ve been over the recent past.  


So… Is The Stock Market Going To Crash?

While the video is entertaining to some degree, I wasn’t convinced that the arguments support his conclusion that we’re on the cusp of an inevitable collapse.  That said, I do expect the volatility will continue, and another crash is certainly within the realm of possibility in the coming months.

Then again, a crash is ALWAYS a possibility.  If you can’t handle that risk, you shouldn’t own stocks. 

So…in summary:

Yes, The Stock Market is going to crash.  Sometime…


What Should I Do About It?

 Be careful getting wound up by watching Doomsday Videos, but don’t ignore the very real risk that stocks will go down.  At some point in our retirement stocks will retreat, potentially for years on end.  I’ve written numerous articles on how to position your retirement savings to defend against a bear. 

Below, I’ll share my previous articles, along with a summary of their content.  If you’re asking “Is the stock market going to crash” and worrying about what to do about it, the following will give you detailed advice and share what I’m doing to protect our portfolio.  Rather than restate my recommended actions for defending your portfolio against a future bear, I’ll let you decide which post most resonates with you: 


  • A Strategy For Buying Into A Bear Market:  The strategy I’ve implemented in 2020 due to increased volatility which automatically rebalances whenever the market has moved more than 5%.  It’s been successful to date, and I’ll post a follow-up to show the ongoing results (Hint:  We sold some stocks after the rebound this summer, refilling Bucket 1 in the process.  I’m continuing to monitor to keep us in the 50-60% stock allocation range).

  • The Benefits of a Bear Market:  My take on the March 2020 bear, and advice for folks to reduce stock allocation “when the market rebounds” if the bear was keeping you up at night.  I hope folks listened and took action following the rebound this summer, if applicable.

  • 6 Steps To Avoid The Looming Bear Market:  6 specific steps to take if you’re asking “Is the stock market going to crash” and worried about what to do.  These steps will help you build a contingency plan that’s appropriate to your risk tolerance.

  • I’m Scared of a Crash, Where Should I Put My Money?  Advice I gave following a 550 point drop in the DJIA, which has been the same advice I’ve given consistently since writing this blog (maintain your targeted asset allocation, rebalance, don’t panic, keep some cash reserves, etc.).

  • How To Build A Retirement Paycheck:  An overview of The Bucket System we’re using to fund our retirement, and how we’re using liquid reserves to avoid selling stocks during a bear market.


Conclusion

It’s normal to ask yourself “Is the stock market going to crash?”.  There are a lot of online personalities who count on those anxieties to drive traffic to their sites.  Avoid the noise, but realize the reality that the stock market WILL crash.  It’s normal, and it will happen again, and again, and again. It’s impossible to predict a market crash, so it pays to be prepared at all times.

Now that we’re retired, a stock market crash has real potential to damage our quality of life.  Having a solid plan is critical prior to your retirement to ensure you avoid the Sequence of Return Risk and avoid being forced to sell stocks during a downturn to fund your lifestyle.  At the same time, to keep up with inflation and cover our retirement expenses, we must achieve the higher returns that stocks have historically offered.

Like most things, the risk of a stock market crash is manageable.  By implementing the suggestions I’ve offered in previous posts, you can sleep well at night in spite of the market’s volatility.  

Develop, then implement, your plan.

You’ll sleep better as a result.


Your Turn:  Do you think a market crash is imminent?  What is your opinion of doomsday videos? What tactics do you employ to defend yourself against the bear?

28 comments

  1. Excellent analysis of investment strategies and the overall market Fritz!

    Of course it will crash and it will also rebound. Over the past 90 years, the stock market has yielded a return of around a 10%. The doomsayers are like Chicken Little claiming the sky is falling. They’re also the ones suggesting we buy on the way up.

    In your opinion, should we fasten our seat belts or are we in for a speed bump?

    1. Shannon, I believe you’re asking me “Is the market going to crash?”. Smiles. If I were a betting man, I’d suspect we’ll see another downturn before we’re done with the COVID and election cycle, with a possible revisit to the March lows not out of the question. No worries here, just sticking to my plan.

    1. Agree with Backpack Finance. Markets have always gone up and down. I am also in favor of the 5% rebalancing rule.

      I also do not read/watch the Chicken Little predictions of market boom and bust. In my opinion, these predictions are designed to gain viewers and/or pump and dump stocks.

  2. I can’t even imagine how much appreciation I’ve lost over 40 years Of investing by listening to doomsday predictions. If I’d have just stayed in the market and not thought I was smarter than everyone else, my net worth would probably be double. (Oh, I guess I CAN imagine).

    When we retired last year we set aside three years of living expenses in a money market “bucket.” Because of that, the Coronavirus crash didn’t lead to one minute of lost sleep. Everyone should have a bucket, whether that’s one, three or five years.

    40 years of investing. I finally learned my lesson on following the Doomsday crowd.

  3. The market for sure is going to pull back. The tech stocks have been leading the rally, however with the debt the US is putting on with the stimulus checks and other social issues it is only a matter of time. Higher taxes in the coming years will also become a reality as we have to pay back the debt. Inflation has to raise its head again, just a fact of markets. Doomsday, no, challenges, YES. Options: (in my opinion only):
    1. raise cash by trimming your winners (use to buy in the next down-turn)
    2. prepare for higher interest rates, floating rate funds will help as interest rates move higher.
    3. TIPS to protect against inflation
    4. Buy bank stocks or funds in next pull back, future higher rates great for banks
    5. Water related, natural resource, and yes if you can stand the pain, energy are good bets next 10 years..

    Just my thoughts love your work.

    1. Dale, I don’t disagree with anything you wrote. We think a lot alike. I would revise your #1 to “Consider increasing your asset allocation holdings in cash and reduce equities if you’re finding your risk tolerance impacted by recent volatility”. It’s important that folks do that by “trimming your winners” now rather than panic and do it after the next correction.

      I also favor buying the dips, as I wrote in the “Strategy for buying the bear” post shared above. I sold some XOM puts during the March downturn, I agree it’s reasonable to buy some inflation hedges when the opportunities present themselves. All within reason, and all in line with your plan.

      1. I wouldn’t limit myself to selling only winners. Tax loss harvesting to balance out winners and losers may make more sense. Of course, the uber point of decreasing equity positions and raising more cash makes perfect sense.

  4. The term “Returning to a mean” bugs me. The mean is an average of things that have happened in the past and can include a sample from “now”. If a stock goes up, the mean goes up. It could do that forever (mathematically-speaking) .Only if the stock comes down, does the mean go down. The first chart above shows a graph line that goes up wildly, yet the mean stays linear. That simply not mathematically correct. It may be “returning to” some expected value, but it’s not the mean.
    Maybe somebody can explain what this really “means” (pun intended).

    1. Howard, I’m actually a big fan of the “Mean Reversion” theory. It’s important to realize the “mean” refers to the LONG term average (I’m not sure exactly how long, but I’d suspect it’s ~10+ years?). If a particular index has been up 20% for the past three years and it’s “mean” return is 10%, it’s reasonable to assume the chances of a correction are higher in the next few years. The chances are better that the 20% years will be hit with a “below average” return in the coming years, bringing the average close to the long term mean of 10%. It’s why I never chase last year’s winners….

      Here’s a link to the definition of Mean Reversion, if interested: https://www.investopedia.com/terms/m/meanreversion.asp

  5. asset allocation matters. i realized something this past feb/march when the market went down my 30-35%. like you, we’re near the end of our accumulation phase so the snowball is pretty large at this point. near the lows i realized that 70% of quite a bit of money is STILL quite a bit of money and it didn’t bother me too much. we stayed the course and bought some stocks with our cash buffer and just reblalance slightly more often but really only after 15-20% moves. i’ll bet y’all have the same basic strategy.

    oh, and i’ve been selling small slivers every week on the way up as planned sales as my growth stocks don’t pay much in dividends. you gotta make your own dividends and the best time is when they make new highs every week. cheers.

  6. Fritz, thanks for another thoughtful post. You end with stating that you need the higher market returns to maintain your retirement lifestyle – just wondering if you’re really depending on the market to meet your goals? Would there be a point where you would no longer need stock market risk, but just work to keep up with inflation? Is your conclusion based on Monte Carlo simulations of your probability of success, including various levels of stock market investment?

    I’m wrestling with how much market risk is ‘necessary‘ for my own finances now that I’m newly retired. It seems the common assumption is that you must live off your portfolio, and it must have a significant portion invested in the market. But if outside income sources come close to covering your expenses, would keeping up with inflation then be your primary concern, and any stock market returns just gravy? I recall you have a pension, but perhaps it hasn’t kicked in yet. Have you modeled your retirement without stock market investments?

    I totally loved your ‘retirement paycheck’ and bucket strategy posts, created my own version of your road to retirement refrigerator map before we retired, and revisited your ultimate retirement checklist at the countdown for peace of mind, so thank you for those! But it seems I may not need to implement the portfolio management (ie paycheck and bucket) strategies I admired so much as my retirement spending, at least for the first 15 years, won’t really depend on investment returns, and principal will most likely be more than sufficient for the rest.

    Are you only taking as much investment risk as required, or as much as you can comfortably handle even if seemingly not required to maintain your lifestyle?

    Thank you for your thoughts and insight!

    1. I am curious about this too. IE is it necessary to take risks once you’ve “made it”? Or is it best to just ratchet down your risk and always make sure you have sufficient assets outside the market for shorter term needs… in the cash and bond buckets.

    2. JMW, I’m afraid I was using a proverbial “we” in the conclusion, not specifically refering to our situation. That said, we are using a conservative asset allocation of 50 – 60% stocks in our retirement portfolio. We could, potentially, eliminate stocks from our allocation, but I have no idea where else we’d invest our money. 100% bonds? Scary thought with the risk of interest rate increases. 100% cash? Wouldn’t keep up with inflation. I do think the longer term growth potential of stocks supports almost everyone maintaining at least some exposure to the sector. We’re at a ~3% SWR, so we’re comfortable that we’ve “won the game”. Even with that, I don’t think it would be wise to exit stocks completely. To answer your question about how much risk we’re taking on, I would say it’s what we can comfortably handle, and likely more than required to maintain our lifestyle. The challening part is the future is always unknown, so you can never really lock down exactly how much is required to maintain your lifestyle until death…

      Also, I’m honored that you’ve implemented so many of the ideas from my previous posts. Glad to know my work is helping you on your journey.

  7. This an absolutely superb article Fritz. You’ve done a particularly stellar job with the presenting the details on both facts and general recommendations. Required reading for the uninitiated and/or under-sophisticated.

    As most savvy investors realize, all markets crash with an almost predictable level of regularity (thanks for including the link). My plan built in a crash every 12 years. It may be a tad over-conservative, but the point is know that it will crash and plan accordingly based upon your individual risk tolerance.

  8. Fritz,
    I’m curious to know how much money George is making for predicting a major market crash. I’ll bet it’s a lot more than he would make if he were predicting a smooth market.

    One point I would add to the many fine points you made is that the annual Dalbar study shows that not only do we not know when the market is going to crash, but we are likely to be wrong more often than not when we try to predict the market’s next move.

  9. Fritz,
    I enjoy reading your articles. I’m not the student of investments that you or the bulk of your readers seem to be. A thought occurs to me after reading the comments on your “Is the Stock Market going to crash?” article. I have an IRA and a Roth IRA – funds that I will probably never need. That is, between my pension and one house that I rent out, I’m breaking even. I’ll have to take Social Security in 2 years when I turn 70, at which time I should be living high-on-the-hog (though, crazy stuff could happen). When the market started it’s dive earlier this year, contrary to most current advice, I jumped out and put it all into CDs (I know… with inflation I’m losing money). I’m down less than 7% from when the market started it’s drop earlier this year, but had been 100% in Index stock funds for over 30 years…so, I’m well ahead overall. With the uncertainties involving COVID-19 and it’s effects on the market, I just don’t want to be in the market – I don’t need more money, I don’t want to worry about the market moves, and I’m OK with some inflation damage (for the time being, anyway…I’ll eventually do something to address that). Tell me I’m wrong (I can take it – and I trust you’ll do it in a kind way).

    1. I’d never say you’re wrong, Alan. Only you can judge your risk tolerance, and since it sounds like you’re in great shape, I think it’s reasonable to declare, “I’ve won”, and quit playing the game. Congratulations on a job well done!

  10. Yes it is going to crash sometimes!
    We need to have the correct mindset to prepare for it as long term investors.
    I hope it crashes one or two times before my retirement days come so that I can accumulate more now!

  11. My engineer husband delights in telling me that every time a plane lands, it is really a controlled crash. The stock market will crash, rise, crash , rise again over the years to come. It is how it works.
    I have ceased to worry about it, and fortunately I am able to ensure that I do not need urgent access to my investments. I continue to invest regularly, don’t try and time anything. I know my limitations!
    So saying my investments, when I looked a couple of weeks ago, were just about back at the level they were mid February, just before they dived 15%, so the yo-yo effect is working as expected….

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