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Don’t Worry About A Sudden Market Crash!

  • Written by Syndicated Publisher No Comments Comments
    January 1, 2014

    There is currently an odd dichotomy in investment sentiment.

    Sentiment as measured by the poll of its members by the American Association of Individual Investors (AAII) shows a high level of bullishness (55.1%) and low level of bearishness (18.5%), levels often seen at market tops.

    The sentiment of investment newsletters as measured by Investors Intelligence is at a rarely seen extreme high bullishness (59.6%) and extreme low bearishness (14.1%).

    Options players, as measured by the VIX Index (aka The Fear Index) are at an extreme low level of fear (high level of bullishness) (but have been all year).

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    But there also seems to be considerable fear, not only of a market correction, but of a sudden market crash in some quarters, at least as indicated by articles in the media, particularly online media, with headlines like:

    “The Probability of a Stock Market Crash Are Soaring.”; “Doomsday Poll: 98% Chance of a Stock Market Crash in 2014.”; “The Looming ObamaCare Market Crash.”; “Stock Market Crash 2014 in Seven Charts.” and so on.

    Scary stuff.

    The phrase ‘market crash’ has become almost as popular as ‘market bubble’ in the rush of one-upmanship to describe market conditions in the most dramatic fashion possible to attract readers.

    However, market crashes are rare events and are impossible to predict. There have been only three markets crashes in the last 84 years, if you count the 1998 ‘mini-crash’ as a crash. (The definition of a market crash always was a decline of more than 10% in one day).

    And here’s the thing.

    Investors seem to think the previous crashes suddenly appeared, as in overnight. So the fear is if another were to take place they might see the market at a record high one day and down 30% the next day, without warning.

    That is most definitely not how previous market crashes took place.

    The 1929 crash:

    The most famous market crash began on Thursday, October 24, 1929 when the Dow was down 11% at the open on very heavy trading volume. However, it then recovered by the close. But the recovery was only temporary. On Monday, October 28, the Dow closed down 13%, a then record one-day decline. And on Tuesday, October 29, 1929 it lost an additional 12%.

    However, that two-day crash took place almost two months after the market top was in.

    As shown in the chart, the market had topped out in early September, 1929. The intermediate-term technical indicators had triggered a sell signal. A head and shoulders top had subsequently formed. And the Dow had already declined 15% before the crash took place.

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    The 1987 crash:

    Similarly, the 1987 crash, in which the Dow lost 22.6% in one day, took place on October 19.

    But the market had topped out on August 25, almost two months earlier. The consensus of the intermediate-term indicators had triggered a sell signal in early September, and the Dow was already down 17.5% when the additional plunge of the crash took place October 19.

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    1998 ‘Mini-Crash’:

    I question whether the so-called 1998 ‘mini-crash’ should be referred to even as a mini-crash. It was actually a 19.2% correction over a six-week span. Its largest one-day decline within the correction was 6.3%.

    But even so, once again the ‘crash’ day didn’t take place until the market had already declined 14% in a correction, which the intermediate-term  technical indicators had pretty much nailed near the top.

    And the crash days were the final two-day capitulation plunge to the correction low.

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    So, intermediate-term corrections, and cyclical bull and bear markets can be predicted with fairly accurate consistency.

    But it’s absolutely impossible to predict when one might include a crash.

    And more importantly, on the rare occasions when there was a crash in the past it was after sell signals had been triggered, and after the market was already down double-digits, and investors should have been out anyway.

    So, surrounding conditions like investor sentiment, market-valuations, the age of the bull market, ‘smart money’ selling, that we remain in the usually negative first two years of the Four-Year Presidential Cycle, monetary and fiscal stimulus being reversed, and so on, indicates a correction, even a bear market, could begin at some point in coming months, perhaps even weeks.

    However, most likely, it would roll over quite timidly from overbought conditions, trigger a timely intermediate-term sell signal, and not be likely to begin with a crash.

    In fact if history is any judge, if a crash were to come in the next market correction it would much more likely be at the end of the correction, when investors finally give up on buy and hold and bail out in capitulation.

    So to sum up, actual market crashes are rare events, only two, possibly three in the last 84 years, each during quite different economic and global conditions, making predicting when another will take place an impossibility.

    But even if investors believe the predictions, there is no need to panic at the thought. There is likely to be ample warning. (Of course, as with all market tops, investor sentiment will be very bullish and euphoric and most investors will not heed the warnings).

    Is Housing Stumbling Or Not?

    The reports are not providing a clear picture.

    Housing starts, existing home sales, and new home sales fell several months in a row, as rising mortgage rates and higher home prices seemed to be having a decided negative effect. But over the last month or two reports have improved.

    Yet this week, the reports have been that Pending Home Sales ticked up slightly, 0.2% in November, to 101.7. That was the first gain in six months, but is only fractionally above the 10-month low of 101.5 in October.

    And the Mortgage Bankers Association reported that mortgage applications fell again last week, this time by 3.5%. Its MBA Purchase Index, shown in the chart, covers only applications for mortgages to be used in purchasing a home. By excluding mortgage applications for refinancing, it shows a clearer picture of housing activity than the numbers that include refinancing apps.

    Yet, the sharp decline in mortgage purchase applications (now at a 13-year low) are also not providing a clear picture because home purchases over the last 18 months have been impacted significantly by large institutions like Blackstone, snapping up the bargain homes by the thousands for rental programs, and paying cash.

    However, comments by officials at Realtor groups are not encouraging.

    And builders are reporting a noticeable drop in traffic by would-be buyers, the latest such reports coming from Lennar, and KB Homes.

    So it’s still questionable whether housing is recovering from its summer and fall stumble or not.

    To read my weekend newspaper column click here:  Investor Expectations Also Need Tapering As We Enter 2014

    Images: Flickr (licence attribution)

    About The Author – Sy Harding, Street Smart Report

    Sy Harding publishes the financial website Street Smart Report Online and a free daily Internet blog at Sy’s Free Blog. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!

    It includes our research and analysis on the economy and markets, and provides charts and buy and sell signals on the major market indexes, sectors, bonds, gold, individual stocks and etf’s, including short-sales and ‘inverse’ etf’s.

    It provides two model portfolios as guides. One is based on ourSeasonal Timing Strategy, one on our Market-Timing Strategy.

    In depth updates are provided every Wednesday, with interim ‘hotline’ updates every time we make a trade. An 8-page traditional newsletter Street Smart Report is provided on the website every 3 weeks, in pdf format for viewing or printing out.

    There is the Street Smart School of online technical analysis ‘seminars’,commentaries to keep you ‘street smart’ about Wall Street, and much more. 

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