Ominous Omens Build for a Stock Market Crash

Stock market crashes destabilize economies and make investors leery. When they happen, a recessionary period marked by slow economic growth usually follows. Because the markets face continuous exposure to risk, it’s tough to predict crashes. They are also impossible to avoid.

In the past, stock market crashes have sent industry experts and investors searching for clues as to why the incident happened in an effort to protect themselves or prevent the next one. By assessing conditions prior to a crash, experts have been able to spot several signs that often precede these events. Those who invest for the long-term are likely to see growth in their portfolios regardless of major stock market incidents, but investors should remain vigilant about the ominous omens that build before a stock market crash.

High Degrees of Margin Debt

Investopedia notes that high levels of margin debt are one factor that may be responsible for sending the stock market tumbling. If investors use margin, they are buying and selling stocks with funds that they’ve borrowed. When the stock market crashed in 2000 and 2007, high levels of margin debt were present. This is also partly why the Chinese stock market crashed in 2015. Some industry experts have confirmed that margin debt grew to higher levels last year than it did during the previous two crashes.

When high margin debt is present, it may be a symptom of a euphoric market. This kind of market consists of investors expanding their stocks to make a quick buck. Because investors are using borrowed funds, the market increases fast. All stocks eventually go back down, so a rapid drop causes investors to liquidate quickly, which brings about panic selling.

Market Bubbles

Bubbles happen in the market from swift stock or asset increases that are followed by a notable decline. Market bubbles have occurred for centuries. For instance, the Bengal Bubble of 1769 materialized when the British East India Company’s shares fell by more than half. Bubbles may develop because of structural changes in business patterns or due to major paradigm modifications like the technology transformations that occurred toward the late 1990s and early 2000s.

Some experts believe that bubbles are an offshoot of human emotion and weakness. When bubbles reach their peak, most investors are unable to conceive of a drop. Then, the financial system experiences a shock or flaws in the structure begin peeking out. This results in people selling their assets or stocks. Industry experts can usually determine the cause of a bubble after one pops.

Bubbles can have a major impact on a country’s economy. Albert Edwards, an economist for Societe Generale, said, “If the U.S. economy tumbles into a recession led by low manufacturing output, the U.S. market will sink by a whopping 75 percent.”

Considerable IPO Activity

An increase in Initial Public Offering, or IPO, activity is another sign that the stock market may be on its way down. When the stock market is strong, companies frequently hurry to offer their shares to investors because they want to take advantage of market growth. Prior to the 1987 market crash, the IPO activity was considerable. That year, 500 IPOs became available totaling about $22.5 billion in raised capital. This was record setting conditions. The technology bubble saw a similar situation in 2000 with 406 IPOs.

During the last two years, the IPO activity has been escalating in the biotech sector. The first half of 2015 saw 50 of them in the category, and they raised more than $5.1 billion. A strong showing in this sector is one of the main reasons that a bullish market occurred at the time. The market is seeing activity in the biotech sector because a number of new oncology therapies recently received the go-ahead from the Food and Drug Administration. This could be the start of a market crash, but investors will have to wait and see.

Learning from the Past

The Telegraph notes that there were warning signs prior to history’s recent crashes. Before world-changing crashes happened like Black Monday in 1987 and the 2008 Great Recession, the VIX index, the U.S. dollar and the price of gold rose as yield on government bonds fell. This situation indicates that investors were heading to safety. Stock markets are mainly compelled by fear and greed. These market indicators reflect the fear that investors were experiencing at the time.

Protecting Your Portfolio

John Husselbee, a Liontrust multi-manager, said, “What set the great crashes apart from my perspective were changes.” When ominous omens begin building, a stock market crash may be imminent. Keep your wealth intact and your portfolio safe by knowing the signs of a crash and with investment diversification. To read more about the signals of a stock market crash, visit the PersonalMoneyStore.com.

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