Stock market crash: 3 things that could sink share prices

With US stocks at all-time highs, a lot of optimism is baked into share prices. But what if these three factors combine to trigger a stock market crash?

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Last week, I wrote two articles listing seven reasons why share prices can keep rising. For example, with global wealth at record highs, a wave of money is flooding into stocks and shares. This explains why the FTSE 100 index is up a twelfth (8.3%) in 2021, while the US S&P 500 index has leapt by almost a sixth (16.2%) this year. However, experience has taught me that share prices never go up in straight lines. Thus, even today, I worry about the next stock market crash. Hence, in the interests of balance, here are three factors that could dent investor optimism.

1. Could ‘Delta’ cause a stock market crash?

In the first quarter of 2020, surging Covid-19 infections triggered one of the steepest stock market crashes in financial history. By ‘Meltdown Monday’ (23 March 2020), equity markets had collapsed by more than a third (35%). Today, vaccination programmes have dramatically slowed hospitalisations and deaths in developed countries. However, the latest Delta variant of coronavirus is far more transmissible and more deadly than previous strains. This Delta variant is sweeping across populous countries including India, Indonesia, Brazil, and Russia. If the Delta variant causes a ‘third wave’, could this send share prices plunging, as happened in autumn 2020?

2. Slowing economic growth

In the first quarter of 2021, the US economy grew by 6.4%. This was the strongest first-quarter growth since 1984 and followed a 4.3% increase in Q4 2020. This growth rate is expected to peak at 9% in Q2, before dropping back to 4.2% in Q4. Thus, the April-June quarter probably marked ‘peak growth’ for the world’s largest economy. With reduced fiscal stimulus (government handouts) on the horizon, growth should ease off in 2021/22. This will likely dampen investor enthusiasm. However, in my view, any sudden slowdown is unlikely on its own to cause a full-blown stock market crash.

3. The rise of inflation

One really big worry for investors — especially those heavy exposed to highly rated US stocks — is rapidly rising inflation. Inflation measures rising prices — and it’s running hot in the US and UK right now. Indeed, the US Consumer Price Index leapt by 5.4% in June on a yearly basis. This was its steepest rise since August 2008 (just before the stock market crash following Lehman Brothers‘ collapse in mid-September 2008). This is well beyond the Federal Reserve’s 2% inflation target used to set monetary policy. Likewise, UK inflation rose sharply in June to 2.5%, ahead of the Bank of England’s 2% target.

The problem really hits hard when runaway inflation takes hold (as happened in the 1970s). Central banks deal with rising prices and wages by raising interest rates. For example, the US Fed Chair at the time, Paul Volcker, brought down inflation by lifting rates to a peak of 20% in January 1981. Of course, such a spike could not happen in today’s world of near-zero and negative interest rates. But even small rate rises by the Federal Reserve or Bank of England could spook investors and trigger a stock market crash.

Now for the good news. Fed Chair Jerome Powell has repeatedly stated that he will keep monetary policy extremely loose until economic growth is well established. Hence, markets are not pricing in US or UK rate rises until late 2022. For me, this is a cue to keep buying into good companies with solid financials and market-beating dividends. And when a stock market crash finally arrives, I’ll buy even more cheap shares!

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services, such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool, we believe that considering a diverse range of insights makes us better investors.

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