The equity markets have made a remarkable recovery in the last year. The coronavirus decimated global economies as governments announced lockdowns and shut their borders. Oil prices experienced a downward spiral due to tepid demand while many retail companies filed for bankruptcies. Airline stocks booked massive losses as international and domestic travel came to a standstill. The S&P 500 ventured into bear market territory in just over a month and declined by 35%. However, since then, the spectacular snapback rally witnessed has confounded investors as well as analysts. The rally was primarily driven by tech stocks that gained momentum due to the shift to remote work as well as the transition towards e-commerce. The S&P 500 Index touched a multi-year low on March 23 last year but ended 2020 with a year-to-date gain of 16%. However, there is a good chance that the stock markets will crash again in 2021 and let’s take a look at few reasons that will drive the decline. A high Shiller price-to-earnings ratio
Several stocks are trading at an expensive valuation. The most common way to value the equity markets is by looking at the price to earnings ratio that stands at 35x right now, compared to its historical average of 17x. However, the Shiller P/E ratio has been in the high 20’s to low 30’s for most of the last ten years. Historically, whenever the equity markets touched a PE ratio of 35, it has been followed by a market correction or even a market crash. Two of these instances were during the Great Depression and the dot-com bubble. Bulls, though, say the high current valuations don’t take into account that as the world shakes off the results of the pandemic the economy will grow much faster, pushing earnings up, thus the P/E ratio down, without leading to a market downturn. Another reason the market may not be falling at this time is that in the last year, several federal governments stepped in and paid billions of dollars to individuals and businesses in order to help them amid the pandemic. The Federal Reserve also lowered interest rates to provide easy access to capital and boost consumer spending and investments. While interest rates are likely to remain near record lows, it will be impossible for governments to keep paying residents a monthly benefit via stimulus programs. In case unemployment rates continue to be high, there is a good chance for another financial crisis to impact the banking industry, similar to the one seen back in 2008, as delinquency rates will move northwards.
The final takeaway
While it is impossible to time the broader market, ProVest is equipped to handle a significant market calamity because of our ability to follow trends and actively step out of the market to protect our investors after a downtrend starts. No one knows where the next market top will be until we’ve already passed it. But when the market starts to tell us the trend is now shifted from going up to going down, we will be ready for it.