3 signs to watch to spot a stock market crash

·4-min read
Failure, risk taking, work stress
Here's what to watch out for. (Image: Getty).

If you knew ahead of time how a particular stock, or market, would move, you would be very well placed to make a lot of money.

Of course, aside from illegal trading activity, we just don’t know what the future holds.

A whole industry centres around providing you with advice about how best to manage your money.

Professionals in this industry use the phrase upside and downside risk.

In other words, they use mathematical models to forecast the most likely outcome based on all available information.

So, let’s look at what they’re looking at to determine how risky the share market has become.

Company profits

The risk to company profits is to the upside. That means the outlook is good.

Major companies are earning big profits again.

"Despite the turbulent times, 86 per cent of companies reported statutory profits for the six months to December," noted online stockbroker CommSec reported that 141 companies of the ASX200 index group reported half-year (interim) profits for the 2020/21 year.

And dividends are returning. Just under 79 per cent of companies issued a dividend (long-term average is 86 per cent). All signs are pointing to an encouraging full year reporting season.

The economy is tracking well.

The risk to the economy is also to the upside.

Corporate Australia’s success makes sense.

Recent economic data shows consumers have taken the economic baton from the government, and businesses, to some degree, are enjoying better trading conditions.

Last week the Westpac-Melbourne Institute Index of Consumer Sentiment increased by 6.2 per cent to 118.8 in April, from 111.8 in March.

The bank says the measure of the size of the spring in shoppers' steps is now at its highest level since August 2010, when Australia's post-GFC rebound and mining boom were in full swing.

And business bosses are reportedly laughing all the way to the bank too.

Last week also saw the National Australia Bank's monthly business survey suggesting bosses across the country are, well, happy — with business conditions last month reaching a "record high" in the survey's 20-plus year history.

Interest rates wild card

The risks here are to the downside – meaning the outlook is troubling the market.

And the downside risks stem from how long it will take for interest rates to rise materially.

While commentary from the Reserve Bank suggests short-term interest rates aren't rising anytime soon, longer-dated interest rates are already moving higher.

The US 10-year bond yield reached 1.74 per cent recently – the highest level it’s been in over a year now.

But it’s since fallen to 1.5 per cent.

Stockbrokers describe rising interest rates as the achilles heel of the market that could cause a correction – a price fall of 10 per cent from the peak of the market.

Again though, those same stockbrokers say it’s literally anyone’s guess as to when rising interest rates will become problematic for the market.

Tech stocks have already taken a hit, because their valuations are particularly vulnerable to rising interest rates, but the majority of stocks are holding strong.

Banks should actually benefit from rising interest rates, assuming they don’t take too much heat out of the property market.

Where does this leave us?

I can’t tell you how many people I know have begun share market trading using smart phone apps.

They’re investing in everything from retail companies to satellite firms.

There’s been mixed success but importantly, they’re excited about making money.

Commsec’s also receiving record levels of inquiries and account set-ups. And when the market gets this hot, it’s exactly what you would expect would happen.

It’s entirely possible the market will continue to rise. Government stimulus is still driving activity, and the word from central banks is that the easy money will continue to flow.

This stock market utopia though can’t last forever.

The really big question is that when the music stops completely, which it must, will there be an orderly exit out of stocks, or will it be chaotic?

I wish I knew.

It’s impossible to assess this risk but the reason why it’s so important to watch is that it’s the difference between taking a big loss and riding out a natural shift in prices.

Like most things, when emotion hits the herd, anything can happen.


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Image: Yahoo Finance
Image: Yahoo Finance