Stock market crash: 4 warnings from billionaire Warren Buffett

After US stock prices tumbled in January, investors are more fearful of a stock market crash. Here’s what the world’s #1 investor thinks about meltdowns…

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After three years of rising global stock prices, investors got a whiff of a stock market crash in January. The US S&P 500 index hit a record 4,818.62 points on 4 January, then plunged. At 2022’s low, it had lost nearly 600 points, hitting 4,222.62 on 24 January after diving 12.4%. But this correction didn’t last and the index closed at 4,515.55 on 31 January. Even so, the S&P 500 was down 5.3% last month, its worst January since the global financial crisis of 2007-09. But had it not bounced back since Wednesday, the S&P 500 would have suffered its worst start to a year in history.

Meanwhile, the tech-dominated Nasdaq Composite index peaked at 16,212.23 points on 19 November 2021. It ended 2021 at 15,644.97, before crashing to a low of 13,094.65 on 24 January. At this point, the Nasdaq had slumped by 16.3% in 2022. However, it also rebounded, ending the month at 14,239.88 to lose 9% in January. This was the index’s steepest monthly fall since November 2008. No wonder investors increasingly worry about the risks of a market meltdown. Here’s what mega-billionaire investment guru Warren Buffett has to say about stock market crashes.

Warren Buffett on stock market crashes

1. Warren on momentum trading

In an interview with CNBC on 10 January 2018, Buffett made this comment about momentum-driven market bubbles. “If you’re buying something because it went up yesterday or last week, that is not a good reason for buying anything. It will get you in trouble over time”. We know that momentum buying can drive up asset prices relentlessly for some time. While the music keeps playing, investors will keep on partying. But when the US Federal Reserve takes away the punchbowl, the party’s over. That’s why many investors worry that rising US interest rates could trigger a stock market crash.

2. Buffett on leverage

Leverage has been a factor in every major stock market crash since 1929. And since 2019, there has been a huge increase in US investors using leverage to enhance returns. Leverage involves borrowing money or using financial derivatives to magnify gains (and losses!) from trades. I view leverage as a double-edged sword, because it can harm as well as help. In 2010, Buffett said, “If you don’t have leverage, you don’t get in trouble. That’s the only way a smart person can go broke, basically. And I’ve always said, ‘If you’re smart, you don’t need it; and if you’re dumb, you shouldn’t be using it'”. 

3. Warren on bubbles and stock market crashes

Near the peak of the dotcom boom, Buffett gave this warning in his letter to Berkshire Hathaway investors in 2000. “A pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons”. These lessons were that Wall Street “will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest”. For me, 2020-21 was the most speculative period I’ve seen since the dotcom bubble burst in 2000. That’s why I’ve been worrying about a stock market crash for several months.

4. Buffett on the next bubble

With 80 years of investing experience, Warren Buffett is a world-class expert on investing psychology and the human condition. In this inquiry interview on 28 March 2010, Buffett testified, “We will have other bubbles in the future. I mean, there’s no question about it”. For me, it’s not a question of if there will be another stock market crash, only when!

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.

Cliffdarcy has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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