When the curtain closes on 2020, we'll be putting one of the wildest year on record for the stock market into the rearview mirror. We've witnessed the quickest bear market decline of at least 30% in history, the fastest rebound from a bear market low to new highs, and multiple single-day nominal point gain and loss records for the iconic Dow Jones Industrial Average (^DJI 0.27%) and broad-based S&P 500 (^GSPC -0.38%).
But I have news for the investment community: A calendar change doesn't mean that stock market concerns just disappear.
Although it's impossible to predict when stock market crashes and corrections will occur, how long they'll last, or how steep the decline will be, there's a pretty good chance that if we see a crash or correction within the next three months, it'll be due to the following four factors.
1. More restrictive coronavirus lockdowns are announced
A glaring concern for the stock market would be if more states, or perhaps even the federal government, once President-elect Joe Biden takes the reins, stepped in and required more coronavirus disease 2019 (COVID-19)-induced lockdowns.
For the time being, Wall Street seems to be OK with a handful of states imposing tighter restrictions. After all, the U.S. economy and the forward-looking stock market aren't always linked at the hip.
What Wall Street is unlikely to be OK with is a slew of credit, loan, and mortgage delinquencies as a result of additional lockdown measures. Remember, Washington hasn't passed any additional stimulus this time around, meaning job losses caused by further shutdowns could quickly test the response of lenders, including banks.
Financial stocks are the backbone of the U.S. economy, and further lockdowns threaten to pump up losses throughout the sector.
2. Vaccine euphoria evaporates
It's also possible that the overwhelmingly positive news delivered on the COVID-19 vaccine front wanes over the next three months.
In November, Pfizer (PFE 1.35%) and BioNTech (BNTX -0.40%) announced a revised 95% vaccine effectiveness in an interim analysis of their late-stage COVID-19 study. Meanwhile, Moderna's late-stage COVE study yielded a vaccine effectiveness of 94.5%. These are pandemic-crushing results.
Then again, we don't know how long these experimental vaccines provide protection against COVID-19, or for that matter how many people are willing to get the vaccine. A Pew Research Center survey in September found that the number of people likely to get the vaccine had fallen from 72% to 51% since May, with those who "definitely" wanted the vaccine (if available today) halving from 42% to 21%. These concerns over the safety and efficacy of a quickly developed vaccine could hamper a return to normalcy.
There may also be distributional challenges. For example, the Pfizer/BioNTech vaccine candidate needs to be stored below 100 degrees Fahrenheit.
The point is, the stock market is pricing in a flawless approval, distribution, and uptake process. That's unlikely to happen.
3. Democrats win both Senate seats in the January runoff
The stock market might also tumble in the coming months is if both Democratic Party candidates win their respective runoff elections Georgia.
Normally, a Senate runoff or two in January wouldn't have much large-scale meaning. However, with Joe Biden winning the White House and Democrats maintaining control of the House of Representatives, a Democrat sweep for Georgia's two remaining Senate seats would lock Republicans and Democrats (plus independents) into a 50-50 tie. Votes that end in a tie in the Senate would be decided by Vice President-elect Kamala Harris.
Wall Street is expecting Republicans to maintain a small majority in the Senate, thereby leading to big-picture gridlock. Spending bills to fund the federal government are likely to be passed, but corporate taxes aren't expected to increase with a split Congress. But if the Democratic Party candidates win in Georgia, all bets on gridlock are suddenly off the table.
If Biden's tax proposal to increase the peak marginal corporate tax rate to 28% from 21% were signed into law, corporate earnings would fall by around 10%.
4. History repeats itself
The stock market could also crash over the next three months if history repeats itself.
Once again, it's impossible to accurately predict when a correction or crash will occur. But we do know that there were 13 total corrections ranging between 10% and 19.9% in the three years following each of the previous eight bear markets, prior to 2020. In many instances, these moves lower in the stock market occurred well before the three-year mark. What this tells us is that new bull markets often endure hiccups, with one or two sizable jolts to be expected following a bear market bottom.
Historical data also shows just how commonplace crashes and corrections can be. According to data from market analytics company Yardeni Research, the S&P 500 has undergone 38 official corrections of at least 10% over the past 71 years. We've also seen well over a dozen moves lower in the benchmark index of at least 6% since the beginning of 2010.
If sentiment were to shift, emotion-driven short-term traders could quickly weigh on the stock market.
Stay the course
The thing is, even if there's a crash or correction in the cards over the next three months, it's no reason to head for the exit.
Although corrections are commonplace, bull markets are even more pronounced. The average correction over the past 71 years has only lasted about six months, whereas bull markets often last for years.
Furthermore, every single correction in history in the Dow Jones and S&P 500 has eventually been wiped away by a bull market rally. The stock market may not come with any guarantees, but long-term investors who buy great companies during periods of correction have an excellent chance to make money over the long run.
If a crash does happen, you should stay the course and, ideally, look to put additional capital to work.