Since March 2020, U.S. stock markets have been on a crazy run that sent the market up by nearly 70 percent, while some stocks soared in triple digits. The frenzy has mainly been backed up by central banks’ and Congress’ stimulus packages, but the unprecedented amount of money being pumped into stocks has created such a sharp unbalance that no amount of stimulus will ever be able to fix it.
In the meantime, authorities will keep enacting more and more packages while our economy rebounds from the several shockwaves triggered by the health crisis. This is why investors continue to take bullish positions since they anticipate that more free money will soon arrive and keep the markets nice and heated. The latest market mania was seen during the GameStop run, and all the fervor that was sparked amongst a new army of retail investors has left Wall Street openly debating whether the market entered a dangerous bubble territory, which might have gotten too incredibly inflated and would likely end up in a major burst.
In essence, a bubble is formed when prices for something run a lot higher than they should rationally be, and we can say this is happening for numerous leading stocks right now. Yale professor and Nobel-winning economist, Robert Shiller, pointed out that “a bubble occurs when people think that the market is going to go up but worry that it may drop. That is where we are”..
The Shiller S&P 500 price-to-earnings ratio is signaling that we’re at nosebleed territory. The average Shiller P/E ratio over the past 150 years was 16.78, but as of February 11, it closed at 35.66. The ratio is based on average inflation-adjusted earnings from the previous 10 years, and now it is at its highest level since the dot-com bubble almost two decades ago. According to several analysts, the stock market was already on the path for a secular correction way before the health crisis started, and ever since then, as the recent wild GameStop run has largely inflated several stock bubbles, that process might have been significantly accelerated.
When stock bubbles expand too much, the markets become highly vulnerable to investors’ sentiment, but emotions are a kettle that could explode at any time. In the long run, what effectively drives equity valuations higher is the growth of operating earnings, but in the short-term, investors’ behavior tends to point to where the markets will go. That’s exactly what we have all been watching during the past few weeks, as Reddit retail investors have been sending garbage stocks to sky-highs. With that in mind, it wouldn’t take much for emotion-driven momentum traders to send the stock market into a downward spiral.
No stock market crash discussion would be complete without mentioning the role the health crisis could still play. Keeping in mind that less than 30 percent of the population affirmed to be confident about the effectiveness of the vaccine, it seems that the health crisis may linger for longer than what was previously forecasted, and that also means that our economy will continue to struggle for much longer.
Lastly, another evidence can be seen in the remarkable decline in buybacks, which have played a notable role in recent years in helping to drive earnings growth. But without this buyback bump, earnings growth could be dramatically slower than expected in 2021 and end up fatally pressuring equities. No matter where we look, we can find several points of exposure inside the markets. At this stage, if only one of these determinants is pushed in the wrong direction that could trigger an epic explosion of the stock price bubble, and crash the markets up to 89 percent, so investors better beware.
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