Stock market crash: should I fear a winter mini-meltdown?

Even after huge gains in US stocks since March 2020, I don’t expect a 2021 stock market crash. But I worry do about a correction before this year ends.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When it comes to stock market crashes, I’ve seen my fair share. I started investing in shares after turning 18 in 1986 (I’m now a 53-year-old Generation X-er). At first, I saw myself as an outstanding stock-picker, as almost every share I bought shot up in value. Then came my first important lesson in investing (and in life).

My first stock market crash: Black Monday

On ‘Black Monday’ (19 October 1987), US stocks and UK shares plunged steeply, with declines continuing for days. In two days, the FTSE 100 index collapsed by almost a quarter (-23%). By mid-November, the UK stock market had lost 36% of its value. Interestingly, the FTSE 100 ended 1987 roughly 4%  ahead (excluding dividends), thus returning a profit in that year. But it took until 1989 for the Footsie to regain its pre-plunge peak. 

My first stock market crash taught me that the steeper the gains, the steeper the risks. When stocks rise steeply and sharply, they can easily become over-valued. After 35 years, I’m now wary of powerful, surging gains, as history tells me these rarely last. Like all winning streaks, bull (rising) markets have beginnings and ends.

High valuations make markets fragile

This vital lesson — beware of bubbly bull markets — was reinforced by the stock market crash of 2000/03. In the late 1990s, I ignored crazily priced dotcom stocks, instead buying lowly rated value shares. As the UK stock market more than halved in value (-52.6%) over 26 months, I bought more and more cheap UK shares. This led to my second important lesson: I always keep cash at hand to buy cheap shares during periodic market meltdowns.

Right now, US stocks are among the most highly valued in history. Indeed, valuations are approaching levels seen in 1929, 2000 and 2007 (before the global financial crisis of 2007/09). Also, at 12 years and counting, this is the longest US bull market I’ve ever experienced. Hence, I’ve stopped investing in expensive US stocks. Today, I prefer the relative safety of high-yielding FTSE 100 shares.

What might happen this winter?

Looking ahead, I wonder whether we will have a ‘winter of discontent’. Or will we see a ‘winter wonderland’ as stock prices keep hitting new heights? One thing I’m fairly sure of is we won’t have a full-blown stock market crash in 2021. For me, there’s far too much money pouring into stocks and shares for them to decline by a fifth (20% is the usual definition of a crash). Then again, I am alert to the possibility of a stock market correction. This is usually defined as a fall of 10% in share prices. I can imagine three problems triggering this scenario. They all relate to our ongoing battle against coronavirus.

If the Delta variant continues to spread, or Covid-19 mutates again, this might lead to new social restrictions. Any whiff of another UK lockdown might send London-listed shares southwards. Second, I’m worried that global growth may already be peaking so corporate earnings growth might subside. Without higher profits to support elevated stock prices, shares might take a few steps back. Third, if inflation gets too embedded in the UK and US economies, monetary policy might need to tighten. And if bond yields rise or interest rates go up, I expect stock markets to go down.

That said, I will keep on buying cheap UK stocks for as long as I view the FTSE 100 as unfairly undervalued!

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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