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23.02.2021 01:31 PM
Stock market crash: expectations and reality

Traders and investors have been recently living with expectations of an imminent collapse of the stock markets. Predictions of the "end of the world" filled the statements of analysts and venerable economists. Youtube video hosting is replete with scary headlines and labels, aiming to grab the attention of the viewer and reader, and then tell them how they will lose their money. However, we will not talk about the collapse of the stock market, but about the possibility of its next bullish cycle, which may last in the next seven to eight years. Nobody knows the future, so why don't we assume that, despite the negative forecasts, the market will continue to grow, especially since there are several reasons for this, which we will discuss in this article.

The current situation in the financial markets is often compared to the collapse of the dot-com bubble that occurred in the 2000s. Meanwhile, despite some similarities, there are significant differences between what happened then and what is happening in the markets now.

Back in the early 2000s, companies generated low profits, now, Big-tech generates very high revenue against the background of the pandemic. In the fourth quarter of 2020, Apple's profit exceeded $111 billion, and Amazon's profit was $125.56 billion.

Yes, there are many speculatively overbought companies in the stock market, but this is not the case in the broad market. The shares included in the S&P 500 have a P/E (price-to-earnings) ratio of 22.1x with a 25-year average of 16.61x. During the 2000 tech bubble, the average P/E ratio exceeded 24x (Figure 1). Today, stocks are indeed expensive, but less than they were in the early 2000s. The situation among the companies included in the Nasdaq index, of course, is more pessimistic, but even there it is associated with a large number of start-ups that have a small-capitalization and have just entered the market, where we are not talking about profits in the coming years. Yes, there are the ever-unprofitable Tesla and Ozon, the overbought Moderna, but this is more of an exception to the rule than the rule.

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Another significant difference is in the terms of financing. During the dot-com boom, the average funding rate was 6% per annum, now it is near zero, and bond investors no longer outpace inflation, unless they invest in junk corporate bonds. At the same time, the Fed continues to print money, and, according to Chairman Jerome Powell, it may take several years to restore employment in the United States, which means that the period of low-interest rates may actually last forever. Even a small increase in bond yields will lead to serious difficulties for the US budget due to the huge amount of government debt approaching $30 trillion, so the Fed will be forced to pursue an ultra-loose policy and increase its balance sheet for many years, and this, in turn, provides the stock market with a cheap influx of new money.

Meanwhile, corporate profits are now more than three times higher than they were at the height of the bubble of the 2000s, and despite the pandemic, they show no signs of slowing down and are growing at an increasingly rapid pace (Figure 2).

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The accelerating introduction of the COVID-19 vaccine, combined with the rapid decline in daily COVID cases, increases the likelihood of a strong economic recovery, and consumers - many of whom will have a new outlook on life, with increased levels of cash in their pockets - will spend money as if there will be no more tomorrow.

At the same time, the global economy is on the verge of introducing a number of fast-growing science-fiction technologies that will increase economic growth and increase labor productivity to a level not seen since the industrial revolution. We are talking about artificial intelligence, autonomous driving, electric cars, advanced robotics, and 3D printing.

Another reason for the possible growth of the stock market is that the US economy will soon be influenced by a positive demographic situation. US demographics suggest that there will be strong long-term demand for a variety of assets, from US stocks to consumer goods. In the coming years, as millennials enter their prime years, they will start buying homes. This is to be followed by Generation Z. Both of these generations together make up more than half of the US population and are now larger than the baby boomer generation and Generation X, which are gradually moving out of the consumer arena (Figure 3).

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Finally, there is another reason that suggests that it may take several years before the "bubble" collapses - this is negative information noise. As a rule, mass disinformation media is rarely right. They usually call for buying when there is very little time left before the crash and offer to sell before the next wave of growth. Also, the psychology of a person is so arranged that danger causes more attention than a sense of calm. Knowing this and trying to capture the attention of viewers and readers, the media specifically catch up with the horror, making money on it.

I'm not calling on you to buy all the companies indiscriminately and investing your money in anything, but to think about the fact that everything may not be as they want to present it to us. It may happen that the current prices, which seem too high to us, will soon turn out to be low enough and make us regret the missed opportunities. This has happened more than once to me personally, and it may happen more than once in the future. Therefore, be careful and follow the rules of money management, and do not believe everything they say. In the end, no one knows the future, and only you and no one else is responsible for your money.

Daniel Adler,
Analytical expert of InstaForex
© 2007-2024
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