Why investors must pay attention to the impending stock market crash
In spite of the uptake in overtly positive economic news, Jeremy Grantham, legendary investor and co-founder of GMO asset management, greeted the new year with the following overcast message to stock market investors:
“The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble. Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behaviour, I believe this event will be recorded as one of the great bubbles of financial history…” This is an excerpt taken from, ‘Waiting for the Last Dance: the hazards of asset allocation in a late-stage major bubble’, published by GMO.
This U.S. market historian and entrepreneur remarked on the intellectually exciting and terrifying nature of the stock market’s activity as the over-expanded financial bubble is set to burst. He issues a further warning to investors that, for many, this sudden overturn is where fortunes are made and lost.
Traditionally after a period of economic uncertainty and unrest, the market fluctuates and its character follows the usual stages in the stock market cycle: accumulation, mark-up, distribution and mark-down. However, if certain conditions are met this cycle can turn into what is referred to as a financial bubble. Generally, a bubble is the combination of a surging price in assets that is driven by an uptake in exuberant market behaviour and typically the asset’s price has been erroneously driven to a peak that is fundamentally disproportionate to its intrinsic value. Once a bubble has begun to take form, the swift onset of inflation continues to expand its influence until a shift causes a sudden decline in value, or a contraction in economic activity and this is what is known as the ‘bubble burst’.
Although the exact cause of a financial bubble is a contentious topic amongst economists, historically bubbles have been as a result of a dramatic shift in investor behaviour. The current climate is of an extremely unique nature as the global economy hovers on the edge of a financial turning point; the return of economic freedom associated with the end of the pandemic. The research of an American economist sought to provide an explanation of the characteristics of a financial crisis in the hopes of creating a method or measurement of predicting one.
1. Displacement – this is when investors start to notice a new paradigm, a product or low interest rates which cause the market to stir.
2. Boom – as a result, prices start to rise and momentum increases as more investors enter the market.
3. Euphoria – when euphoria hits and asset prices skyrocket, it could be said that caution on the part of investors takes a backseat as the short-term returns cause mass market activity.
4. Profit-taking – those who pre-empt the bubble burst will make money from selling-off their positions at this peak point.
5. Panic – asset prices begin to steady and change course, investors panic and seek to liquidate at any price. This causes a domino effect as the more investors that liquidate, the more rapidly assets decline and supply outstrips demand. The bubble has burst.
If we look to the above stages of a financial bubble burst and we apply these to the current stock market position regarding cryptocurrencies or the very recent GameStop scandal, we can notice the market’s recent activity is somewhat reflected. The trading market is teetering on the edge of possibly one of the largest shifts in investor behaviour in history, as eager as we all may be to reach the end of the health restriction austerity it has the potential to burst the stock market bubble and cause one of the most devastating wealth re-distributions in history. Investors have been warned as the bursting of the financial bubble and the withdrawal of assets at the wrong time in the scale could lead many to lose years of accumulated wealth.
Economists are increasingly upping the scale of their warnings in line with many having recognised the early signs of a financial bubble burst looming over the stock market, with the increasing probability of an impending crash. Correspondingly, many sources have reported a dramatic uptake in the volume of investors who are liquidating their stock positions and switching to fixed term and interest investment opportunities in bonds and development finance. The property market’s stellar and consistent performance throughout the pandemic this year has provided an attractive alternative investment route for many a spurned stock investor.