It's safe to say that this has been a year like none other. The coronavirus disease 2019 (COVID-19) pandemic has done one heck of a number on equities, and completely upended our social habits. We've witnessed the quickest bear market decline of at least 30% in history, as well as the fastest rebound to new all-time highs from a bear market low on record.
But as we've learned throughout the month of September, volatility hasn't taken a vacation. We could very well have another stock market crash waiting for investors in the fourth quarter. Here are seven reasons a crash or correction may be imminent.
Image source: Getty Images.
1. Another round of shutdowns becomes necessary
The pandemic is the most obvious of all possible reasons for a crash. Coronavirus infections could worsen considerably during the fall. Let's not forget that the scientific community is still learning about the SARS-CoV-2 virus that causes COVID-19, as well as how the infection spreads. Even though President Trump has noted that he wouldn't shut down the country's nonessential businesses again, individual governors in critical states, such as California or New York, may choose to do so. That would mean, once again, readjusting corporate profit forecasts down.
2. Coronavirus vaccines fail to live up to the hype
Another reason the stock market could crash is if the hype surrounding coronavirus vaccines fails to match expectations. Even though clinical trials are advancing at a breakneck pace, researchers have suggested that we may need a vaccine efficacy of as high as 80% to really nip the spread of COVID-19 in the bud. If the efficacy of these late-stage candidates fails to hit this mark, or if adverse events arise in any of the most promising trials, we could see a wave of pessimism sweep over equities.
3. Loan delinquencies soar
The lack of agreement on Capitol Hill over another round of stimulus funding is another cause for concern. Between April 1 and July 31, tens of millions of unemployed persons were saved from disaster by enhanced unemployment benefits. Many small businesses were also spared thanks to forgivable federal loans. However, with enhanced unemployment benefits halted and another round of stimulus on hold, we're liable to see a marked uptick in mortgage, credit, loan, and rental delinquencies in the months ahead.
Financial stocks are the backbone of the U.S. economy, and if they begin to falter, the broader market may follow.
President Trump speaking with reporters. Image source: Official White House Photo by Andrea Hanks.
4. Election uncertainty boils over
Wall Street is a big fan of certainty. Right now, it seems like Democratic Party challenger Joe Biden will win the presidency in November. But if polling numbers begin to tighten following the three upcoming debates between Biden and incumbent Republican Donald Trump, we could see serious downside in the stock market. Even though Biden wants to increase corporate taxation, which would limit earnings growth, Wall Street is far more concerned for now with the possibility of an uncertain election.
5. The U.S.-China trade war reescalates
Don't overlook the possibility of previously buried issues resurfacing. The trade war between the U.S. and China was presumed to be water under the bridge when the two sides signed a phase 1 deal in mid-January. Then the coronavirus pandemic struck and completely halted any progress that could have been made on future agreements. In recent months, trade tensions between the U.S. and China have subtly been reignited. If the two largest countries in the world by gross domestic product decide to square off with tariffs in an already weakened global economy, the results could be disastrous.
6. Emotions get the better of investors
If 2020 has taught us anything, it's to never underestimate the irrationality of short-term investors. Over the long term, operating earnings growth is what drives equity valuations higher. But in the very short-term, fear and exuberance can pummel equities or power them to new highs without any connectable fundamental reason. If sentiment were to notably shift, as it did in late February, it would not be difficult to send the stock market careening over a cliff.
Image source: Getty Images.
7. History prevails
Seventh and finally, history could prove itself correct once again. In each of the past eight bear markets dating back to 1960, there have been 13 stock market corrections -- or drops of at least 10% (not rounded) -- within three years following a bear market bottom. This is to say that every rebound from a bear market low over the past six decades has featured one or two sizable corrections, often well before the three-year mark. If equities follow history, we'll be due for a substantive move lower sooner rather than later.
History favors long-term investors
As much as the idea of a second stock market crash probably scares investors -- especially since their memories of the violent five-week decline between Feb. 19 and March 23 are still fresh -- it would actually be fantastic news to those folks who have a long investing horizon.
Since the beginning of 1950, the S&P 500 (^GSPC -0.22%) has undergone 38 official corrections of at least 10%. Eventually, every single one of these moves lower was firmly erased by a bull market rally. We may not know when a correction will occur, how long it'll take to hit bottom, or where that bottom will be, but we do know that, over time, operating earnings growth pushes high-quality businesses and U.S. stock indexes like the S&P 500 higher.
This means any notable decline in equities presents the perfect opportunity for long-term investors to put their money to work in innovative businesses and/or time-tested companies that make money.
Image source: Getty Images.
A stock market crash or correction would also be a suitable time for investors to review their holdings -- though you don't have to wait for a crash to do this. Specifically, ask yourself if the reasons you bought into a stock still hold true. A stock market plunge isn't likely to change your initial investment thesis, which ultimately means there's no reason to sell. Only when your initial thesis has been broken is it worth selling one or more of your holdings.
Yes, stock market corrections and crashes can be unnerving. But they can really pay off over the long run if you have the right mindset when they occur.
