It has always been a rollercoaster, and stocks have always reached thrilling highs and stomach-churning lows. But for some investors, one question bubbles back to the surface in times of uncertainty or volatility: Will the stock market crash?
No one can predict market crashes perfectly, but knowing what causes them, how they’ve happened in the past and how to shield your portfolio can help you make better decisions with your money. That’s precisely what this blog is offering: a rundown on all things related to stock market crashes, from what causes them and expert takes on the odds of a crash occurring again, to actionable advice to protect your portfolio.
What Is a Stock Market Crash?
But before discussing whether a crash is near, we need to define what a stock market crash is. A stock market crash is generally considered to have a sudden and drastic decline in stock prices over a short period, which is induced by fears or panic of the overall market, the economy or politics, rather than having typical or specific fundamental reasons. These crashes inflict huge losses on investors, and their ripples extend through the broader economy.
Stock market crashes are not the same thing as corrections:
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Market Correction: A drop of approximately 10 percent from recent highs, often heard to be a normal and healthy development for long-term market expansion.
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Market Crash: A more dramatic drop of 20% or higher, that causes panic and the worry of economic instability.
Some of the most well‐known crashes in history are – The Wall Street Crash in 1929 at the back of the Great Depression, Black Monday Crash in 1987, and the 2008 Global Financial Crisis. While painful, these crashes were also followed by recoveries that spanned time, underscoring the resilience of financial markets.
Why Does the Stock Market Crash?
Knowing why stock market crashes happen can help prepare investors for when they come.
Market Crash: What Causes It?
Causes of market crashes can vary, but here are a few common ones:
Economic Slowdowns
Investor confidence erodes when economic fundamentals, such as GDP growth, employment, and consumer spending, slow down. This tends to trigger a stock selloff, sending market indicators lower.
Sample Question: A drop in the subprime mortgage market led to the 2008 Financial Crisis, which threw global markets into a recession.
Inflation and Rates Are Rising
Rising inflation erodes the purchasing power of consumers and businesses and can curtail economic growth. Also, when central banks raise interest rates to fight inflation, it becomes more expensive for companies to borrow, which cuts into investments and profits.
Current Example: In 2022, surging inflation worldwide prompted fears of interest rate increases, leading to stock market volatility.
Overvaluation of Stocks
An overvalued market occurs when stock prices are higher than the underlying fundamentals, or the actual value of the stocks. Finally, a correction (or crash) restores prices to also be consistent with fundamentals.
Example: The Dot-Com Crash happened at the beginning of the 2000s because there was too much speculation in internet companies that did not even have a business to begin with.
Geopolitical Tensions
Conflicts, trade disputes, and other geopolitical tensions sow uncertainty in global markets. During these phases, investors typically flock to the safety of fixed-income assets, which fuels a selloff in the markets.
Example: The 2022 Russia-Ukraine conflict raised market fears and disrupted global supply chains.
Widespread Panic Selling
Human psychology has something to do with it, too. When markets start to fall, fear becomes contagious and panic selling sets in, exacerbating declines. That “herding behavior” exacerbates and turns corrections into outright crashes.
Example: Widespread panic selling commenced in the COVID-19 pandemic in March 2020, which forced central banks to step in to protect the market.
Investors who track these indicators can get ready for downturns rather than be ambushed by them.
Is Another Stock Market Crash Coming?
Though it is difficult to predict the timing of crashes, at least some financial specialists have mixed opinions, according to the current state of the markets:
- Best Case: Bulls insist that the underlying strength of corporate earnings and consumer spending will prevent a crash, despite surging interest rates and fears of an inflationary spiral.
- Worst Case: There are still analysts who predict either a bear market or correction as a result of heightened inflation, global instability, and tighter monetary policy.
Key Data to Watch
Here are some of the key signals investors should watch for in markets:
- Data on Unemployment: Increasing unemployment indicates a slowing economy.
- Earnings Reports: Soft corporate earnings might inspire sell-offs.
- Fed Policy: Rate hikes – aggressively pursued by the Fed in the past – have led to market corrections.
- Yield Curve: A so-called inverted yield curve (where short-term interest rates are higher than long-term rates) has historically been an indicator that a recession is coming.
No one can say for sure when or how bad the next crash will be, but knowledge of these matters can help investors make the right decisions.
What to Do if the Market Crashes
The market may crash or it might not, but always make good and responsible decisions to ward off unnecessary risks. Here are some strategies that have been successful:
Diversify Your Investments
Don’t bet the farm. You should diversify your portfolio from various asset classes, sectors, and places of investment to minimize risk. For example:
- Stocks (U.S. and foreign)
- Bonds
- Real Estate
- Cash or cash equivalents
Invest for the Long Term
The historical record is clear: Markets do come back. Look at the S&P 500, which came roaring back after each plummet. Stop trying to “time” the market — and if you’re interested in long-term growth, hold onto high-quality assets even when markets go haywire.
Hold Cash Reserves
It is well-positioned to invest when the stock market is deep in the doldrums thanks to having a pile of cash to back it up.
Rebalance Your Portfolio
Markets can do the work of changing your asset allocation for you. Review your portfolio on a regular basis to make sure that it is in line with your risk tolerance and your investment objectives, and make changes to your allocations as necessary.
Invest in Defensive Assets
Think about “safe” assets in uncertain times, such as utilities, health care, consumer staples or government bonds, which perform well in downturns.
Keep Calm and Do Not Make Any Emotional Decision
Market collapses trigger panic selling and usually end in enormous long-term losses. Instead, remain disciplined and follow through with your investment plan.
If you need assistance on how to apply those strategies, a financial planner can help you create a bulletproof portfolio.
What’s a Young Investor to Do?
When you first begin investing, market crashes can seem daunting. Here’s some advice:
- Take It Step by Step: Invest small at the start, only amounts you wouldn’t mind losing.
- Focus on Emergency Fund: You should have saved at least 3-6 months’ worth of living expenses saved up before investing.
- Think Long: Time is all you have, Kid! And even if the market corrects, if you stay disciplined with your investments, you’ll gradually grow your wealth.
Keep in mind, every stock market crash in history has ultimately been followed by a recovery. Patience and information are the keys.
Get Ready to Be Ready To Protect
We can never predict when or if the stock market will crash, but if we do a good job of understanding crashes, their causes, and prepare for them, we can decrease risk and be set up for success, even in the midst of tumultuous times. Begin with a diversified portfolio, education, and a long-term perspective.
To learn more about smart investing in volatile markets, check out our beginner’s guide to financial uncertainty. In the volatile world of investing, knowledge is your best asset.
Just remain confident, remain informed, and invest smartly.
