Is the stock market going to crash? That’s the question being asked by many who have commented on the recent 30-year anniversary of the 1987 crash. Reviewing that historical marker, Mark Hulbert does a good job in his Wall Street Journal article re-animating that day for us.
“The Dow Jones Industrial Average fell 22.6% on what came to be known as 1987’s Black Monday. An equivalent drop today would be a single-session decline of more than 5,100 points. It was the worst one-day crash by far in U.S. stock market history; the next worst was October 29, 1929, when the Dow fell ‘just’ 12.8% (followed by nearly as bad a drop the next day).”
Mr. Hulbert goes on to offer a fairly well-balanced article citing those who feel we’re due for a crash of some sort and those who believe those fears are overstated.
“Assuming that the current bull market began in March 2009, it is the second longest in U.S. history. By many valuation measures, the current market is more overvalued than at almost any other time in U.S. History.” With that background, Yale University’s School of Management cites the belief that there is a “20.8% probability of a 1929 or 1987 magnitude crash in the next six months”.
Comfortingly, one of Yale’s finance professors feels “the actual probability is surely much lower than this… Researchers have been unable to find that either bull-market length or high valuations are significantly correlated with the probability of a crash. After all, the 1987 crash occurred when that decade’s bull market was just five years old.”
So, just after the 30th anniversary of the worst crash in our history, we’re left with inconclusive opinions based on various readings of market dynamics and patterns. Into this, we offer our own observations on what to expect and why.
If our current economic expansion lasts another 1 ½ years, it will be the longest on record, surpassing the 1990’s expansion. But being the longest is not the same as being the best. The difference may seem semantic, but it is critically important to any reasoned understanding of where we are today.
From the bottom of the recession to the peak of the recovery, real GDP grew 39% in the 1980s and grew 43% in the 1990s. Our current recovery (from recession bottom through October 2017) has only grown 19%. 8 years after the March 2009 bottom, we have barely grown half as much as experienced during these previous recoveries.
We don’t put much weight on measures of length as an indicator of economic activity. Much more important is the actual amount of growth experienced and the prognosis for future growth. We have come a long way, measured in years, from 2009, and we believe there is easily another 18 months of solid recovery ahead of us. But even with that prediction, we will not arrive at some predetermined crash point. There will be nothing magical or inevitable about that date. We won’t “need” a crash then, or now, to somehow achieve the proper valuation metric for the Dow, or the S&P, or any other equity index. We will simply have made up more of the ground lost in the 2008-09 “great recession”.
The economic vibrancy of the U.S. economy is the primary indicator of market valuations. We’ve commented before, but it bears repeating, that the stock market is simply a valuation of the economy. The “stock market” is the present value of all the projected future profits of all the publicly traded companies. It can be influenced by emotions – both irrational fear and irrational exuberance – but ultimately it cannot be controlled by those emotions.
We look at real economic activity and the financial strength of the major players to form our assessment of the market’s strength and direction. Today, profits are strong, balance sheets are very healthy, consumer financial obligations remain low as a share of consumer disposable income, home builders have not overbuilt, and bank capital ratios are much better than they were before the financial crisis. In all the key areas, we see health, vibrancy, and room for more expansion and growth.
On the public policy front, the political leanings are also encouraging. Excessive regulatory burdens are being lifted, tax changes should encourage more investment and job creation, and the Fed seems to understand that rates must rise, but must do so at a manageable and predictable pace.
Now politicians remain politicians, so there is always some chance of a significant collective legislative mistake which would hurt growth (and thus the markets), but none are on the drawing board at this point. North Korea remains a menace, but even its provocations can, and will, be dealt with, and they should represent temporary economic setbacks at worst.
Will there be another recession? Yeah, we can count on it. We just don’t see a high likelihood over the next 18 months or so. Even then, it’s liable to be mild, certainly unpredictable, and fear of it will always cause more harm than the recession itself.
On this last point, consider that the great recession took away (temporarily) 55% of the market’s value, but the recovery gave back 265%. The net return over the full 10-year swing was a 66% rate of return from the 2007 high to October 2017’s market close. Recessions come, and they go. Rarely are they as severe as this last one; but they always give back what they take away. Stay calm and stay invested.
