Stock Market Crash 2.0: A Perfect Storm Is Brewing

And it has nothing to do with equity valuations.

Sean Williams(TMFUltraLong)

It’s been nothing short of a crazy year for Wall Street and investors. The panic and uncertainty caused by the unprecedented coronavirus disease 2019 (COVID-19) pandemic initially sent the broad-based S&P 500 (SNPINDEX:^SPX) lower by 34% in just under five weeks. The 17 calendar days it took for the index to fall from an all-time high into bear market territory, as well as the roughly four calendar weeks it took for losses to total more than 30%, are both records.

However, we’ve also witnessed the most ferocious rally in the history of the benchmark S&P 500. It took less than five months for the index to erase all of its coronavirus crash losses. As of this writing, it still sits higher on a year-to-date basis despite this week’s losses.

Historically, buying equities during periods of correction has proved to be a smart move. That’s because every correction in stock market history has eventually been erased by a bull market rally. If investors are patient enough and diligent about choosing great businesses, operating earnings growth favors equity valuation expansion over time.

IMAGE SOURCE: GETTY IMAGES.

High valuations alone don’t merit a stock market crash

But after witnessing one of the most violent bear market crashes in stock market history and its subsequent snapback rally, I can’t help but feel that Wall Street is set up for disappointment.

Many folks, including myself, have pointed to valuation as a reason to be concerned about a second stock market crash. The Shiller price-to-earnings ratio — a P/E ratio based on average inflation-adjusted earnings from the previous 10 years — currently sits at 33. It has only spent any considerable amount of time above a P/E ratio of 30 on three occasions: just prior to the Great Depression, just prior the bursting of the dot-com bubble, and just prior to the fourth-quarter swoon for equities in 2018. In other words, a Shiller P/E above 30 is usually bad news. 

Then again, we’ve learned that valuation can be an arbitrary indicator for game-changing businesses. Dominant players in an industry, like Amazon, Netflix, and Shopify, pay little heed to traditional fundamental metrics and continue to head higher.

Generally speaking, valuation isn’t enough justification for a stock market crash.

This is what a perfect storm looks like for equities

However, that doesn’t mean the stock market gets a free pass. Right now, there are three monumental catalysts that bode ill for equities. Even with an exceptionally dovish Federal Reserve blowing wind in the sails of the stock market, a perfect storm appears to be brewing that could ravage equities in the months ahead…….more here

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