Last year was phenomenal for the U.S. stock market. It’s had a fantastic run since the dark days of 2008. But the question on everyone’s mind is: How long can this last? And will we pay for it with another gut-wrenching crash? Here’s what our current economic situation suggests.
Let’s start with the good news:
Most of these positive indicators refer to the economy in general rather than the stock market specifically; however, the two are connected. Historically, the stock market has fallen in advance of recessions. Fortunately, the likelihood of a recession seems low at the moment. This continuing (and potentially accelerating) economic growth is likely to support the stock market.
On the other hand, there are several reasons for concern:
None of these negative issues are currently affecting the stock market, but they may at some point.
So what will happen to the stock market? To answer that question we first have to establish what exactly we mean when we talk about an “end” to the rise of the stock market. Three terms are widely used when referring to drops in the stock market, and each applies to a different situation.
Correction: When the stock market falls by greater than 10 percent but less than 20 percent. Corrections are fairly common. From 1900 through 2016, a 10 percent or greater drop occurred once a year on average (Capital Research and Management Group – A History of Declines 1900 – December 2016).
Bear Market: The term used when the stock market falls by greater than 20 percent. Bear markets are less common than corrections, but still occur once every 3.5 years (Capital Research and Management Group – A History of Declines 1900 – December 2016).
Crash: There’s no official threshold for this term, but it usually refers to an abrupt and unanticipated drop, say 10 percent or more in a short period of time. Crashes are much less common than corrections or bear markets. Since 1900, there have been three major crashes in the U.S. stock market: the Crash of 1929 (-23 percent in two days), Black Monday in 1987 (-20 percent in a day), and the Crash of 2008-2009 (-20 percent within a week).
Given that it’s been two years since the last correction and roughly eight years since the last bear market, we are clearly due for a market downdraft. But there’s no sure way to determine when it will happen and what it will look like.
I like to keep in mind a quote about the stock market often attributed to noted American financier, John Pierpont Morgan. When asked what the stock market would do, he succinctly responded: “It will fluctuate.” That’s been true since it first opened and will continue to be true until it closes.
We’d all love to know when the market will drop. But history has proven that’s an impossible task. Your best bet is to accept that the market will go down at some point and invest accordingly. Keep in mind that despite corrections, bear markets, and crashes, the stock market has delivered phenomenal returns over time. In closing, here’s a quote from noted investor Peter Lynch:
"Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves."