The year 2019 ended with a spectacular rally despite all the uncertainties and is officially one of the best years for stock markets. Today, after this great performance, a rising number of analysts and economists are predicting a stock market crash for 2020.
The prediction of economic crisis from economists is going on since the 2008 meltdown: from the European debt crisis of 2010, to 2013 announcements of tapering, from 2015 China’s slowdown to Brexit and trade wars.
While there have been periods of sell-offs, we haven’t seen any major market crash following these events.
In short, a market crash was predicted many times over the last decade.
In the last two years however, the number of people talking about a market crash is getting bigger, and several things could go wrong and start a downturn.
This chart from Mark Zandi, chief economist at Moody’s Analytics, pictures a list of potential triggers of a recession and estimates the impact that they would have on the economy.
If you are pessimistic, there are all sort of things that could go wrong like: the U.S. government can’t push the economy further, a rising inflation forces the Fed to rise interest rates, the huge deficits in all developed countries can’t be sustained any longer, negative outcomes from trade wars, all the money printing that pushed stock prices incredibly high that the only way is down…
Those are all possibilities and it is good to have in one’s radar what could happen. However, if you listened to all the doomsayers and you invested by looking only at what can go badly, you would have missed on the great returns that the stock market delivered.
A recession will come, at the end, but it costs a lot to time it wrongly.
The inversion of the yield curve brought rising concerns about a potential crash and lead the Fed to be even more accommodative with monetary policy and lower interest rates in 2019. While in the beginning of 2019 the Fed was headed towards rising interest rates, right now it is much more supportive of the economy.
At the end of the day, today’s economy appears to have a strong momentum and still doesn’t look like a recession. While this view sounds good for investors, we should bear in mind that recessions happen frequently and that bull markets don’t last forever.
If you take any long-term chart of the stock market you can clearly see that in the long run it always goes up. However, we are obviously interested in understanding “what part of the long run are we in”, because the long run growth is always pointed by crisis and market crashes.
Nobody knows for sure when these crashes happen, but what we do know is that they happen and every now and then we get to see recessions.
This is totally normal and in the nature of financial markets, so market crashes and recessions should not be seen as unpredictable and unforeseeable events.
Recessions and Market Crashes
Recession happen because of too much debt in the system. Today we have more debt than ever before in history, that could really be one of the reasons for the next recession.
However, how much debt is too much?
After all, things seem to be doing great right now and we haven’t yet seen a clear sign of recession. Furthermore, central banks are helping the economy by lowering interest rates while the economy it still doing good. Although this allows for the bull market to continue, it leads us into unexplored territory and leaves central banks with less tools to fight a recession.
For what we know, this economic expansion could continue for some other years.
The economy reacts to all kinds of circumstances and events and every time it’s slightly different. We should be honest with ourselves and recognize that we can’t really predict the stock market like it was an exact science.
To answer the question:
- Should we expect a recession? Yes, sooner or later.
- Should we expect it in 2020? Who knows! Every answer to this question is a guess.
It totally could manifest in 2020 and at the same time the economy could go on for another couple of years. Many predicted the recession by the end of 2019, and we should not be surprised that they were wrong.
Honestly, I think you will agree with me if I say that is a guess to time a potential outcome, subject to thousands of variables that you don’t even know how they will play out and interact.
The key concepts to understand about the economy and financial markets are that:
- They are cyclical
- A recession will happen
If an investor really acknowledges that the market is cyclical and organizes his investing strategy accordingly, he can begin to prepare now for what could happen in the next years and do pretty good whether a market crash shows up or not.
Stocks Gets Overpriced AND UNDERPRICED
The debt cycle and the succession of expansion and contraction of the economy has direct consequences on the valuation of stocks.
Today many companies are priced way too high in relation to their actual worth. When the irrational exuberance of the market stops, the price of those companies falls.
Remember that the price of a stock is whatever someone is willing to pay for it today. It depends on market forces, namely the dynamics between a large number of potential buyers and potential sellers that place their orders on the stock market.
Stock markets prices can go anywhere and reach levels that have little or no connection with business fundamentals. We have seen stock market bubble bursts before, we have seen that a number of times. It can happen again and will happen again.
Today’s valuations are not cheap, they appear quite stretched. Just to give an example, S&P 500’s forward PE multiple is higher than the five-year and ten-year average. Is the entire market overvalued? Will earnings continue to grow to sustain the bull market?
Another thing to consider is that, thanks to low interest rates for a long period of time, many companies have taken huge amounts of debt that can easily transform into debt burdens if interest rates go up or revenues go down.
If a large number of companies gets in trouble, that would cause people to lose their job, and if people lose their job, they cut down spending and a negative cycle goes on. Meanwhile, government intervention and monetary policy might not be fast and effective enough to help.
In this scenario, emotions and fear take over and it is easy to see a crash. This doesn’t necessarily have to happen in 2020,
Markets don’t crash for no reason and they will not crash until investors pull their money out of the stock market.
This leads us to the most interesting and valuable part of this article: what we can do in this situation.
A Ton Opportunities for Smart Investors
Empirical evidence suggests that often times there is a substantial difference between price and value of stocks. Indeed, the stock price changes every day and doesn’t necessarily reflects the true underlying value of the company.
We all know Warren Buffett, he expressed this concept in a very clear way in the 1993 letter to shareholders
“In the short-run, the market is a voting machine – reflecting a voter-registration test that requires only money, not intelligence or emotional stability – but in the long-run, the market is a weighing machine.”
During a downturn, when things start getting bad, investors and fund managers want to take the way out. In this kind of situations, prices on the stock market are the result of acting emotionally instead of rationally.
While during the upside part market participants are willing to pay for stocks with high valuations, during panic they sell at any price, even extremely low compared to the value of the business.
Value investing is considered to be one of the most successful strategies for long-term investing and it is entirely based on spotting the difference between price and value and act rationally upon that.
If you are able to look at the market objectively and keep your mind cool “while the world seems to be falling apart”, you should not fear market crashes because they provide extreme buying opportunities to increase your long-term wealth.
Think about that, the stock market is the only place on earth that when things go on sale, people run away.
While in the short-term stocks may get mispriced, over a long period of time the investment performance converges with business performance. By focusing on the businesses instead of the stocks and seeking value in the companies, it is possible to find value at reasonable prices.
Will we see a recession and a market crash in 2020? Nobody really knows.
If you are an investor that is serious about his portfolio, you should know in advance what to do in both situations in order to avoid to act emotionally whatever happens on the markets.
This results into a huge advantage over other investors and will translate into amazing returns for your portfolio.
- A market crash was predicted many times over the last decade
- There are lots of risk factors that could potentially lead to a crisis
- The economy still has strong momentum and is supported by monetary policy
- Financial markets are cyclical and recessions happen
- Stock prices can go anywhere and stocks get overvalued and undervalued
- During market crashes emotions take over and is possible to find extreme buying opportunities
- Knowing in advance what to do and focusing on business fundamentals is a key to great investing returns
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