What a year it’s been for Wall Street and investors. The unprecedented coronavirus disease 2019 (COVID-19) pandemic initially clobbered the broad-based S&P 500 (SNPINDEX:^SPX) and sent it lower by 34% in under five weeks. This marked the steepest 30% bear market decline in history. But it was followed by the strongest rally from a bear market bottom to new all-time highs on record, with the S&P 500 taking less than five months to accomplish the feat.
If there’s been one constant in 2020 aside from volatility, it’s that predicting the short-term movements of the stock market with any accuracy simply can’t be done.
However, this year has also brought home the fact that stock market crashes can occur anytime and without warning. For instance, we witnessed the Nasdaq Composite lose 10% of its value in a three-day stretch between Sept. 4 and Sept. 8. Crashes have happened before, and they’ll happen again.
Below you’ll find seven reasons why stock market crash 2.0 may be closer than you realize.
1. Yet another COVID-19 resurgence
It probably goes without saying, but the most logical harbinger of the next stock market crash would be a resurgence in COVID-19 infections in the U.S. Although Donald Trump has been adamant that he wouldn’t shut nonessential businesses down if another wave of infections hit, individual state governors may choose to do just that.
Furthermore, if Democratic Party challenger Joe Biden wins the November election, he’s noted that he would shut the country down again if advised to do so by top health regulators.
There are obviously a lot of moving pieces here, but COVID-19 infection rates could play a big role regarding the near-term health of the U.S. economy and stock market.
2. Coronavirus vaccines fail to live up to the hype
Don’t overlook the possibility that coronavirus vaccine hype completely fizzles out. This past week, AstraZeneca (NYSE:AZN) announced that it was putting trials of its leading COVID-19 vaccine, which was developed in cooperation with the University of Oxford, on hold due to a possible severe adverse reaction in a U.K. patient. AstraZeneca has one of the most advanced coronavirus vaccine candidates in late-stage trials. The news could be the first of many blows on either the safety or efficacy front.
Also, recent surveys have shown that a significant number of people have no intention of getting the vaccine. An August-released survey from national pollster Gallup found that 35% of Americans wouldn’t get the vaccine even if it were available today, free, and approved by the Food and Drug Administration.
3. Election uncertainty
Election Day uncertainty could also tank the stock market.
Wall Street is a big fan of knowing what’s going to happen months or years in advance. Right now, Joe Biden is leading Republican incumbent Donald Trump by a reasonable margin in most polls. However, Biden’s lead narrowed modestly following the Republican National Convention. If this gap were to continue to shrink following upcoming presidential debates, Wall Street might not be pleased, and we could see wild vacillations in the market.
4. Stimulus struggles tank the financial sector
The stock market could also be clobbered by Capitol Hill’s inability to pass another round of stimulus legislation. As a refresher, enhanced unemployment benefits, which provided an extra $600 a week to approved unemployed beneficiaries, expired on July 31.
Without enhanced unemployment benefits and added protections for distressed industries and small businesses, we could see loan, credit, mortgage, and rental delinquencies soar in the remaining months of 2020. A significant uptick in loan delinquencies would adversely impact big and small financial institutions alike. Investors love their tech stocks in 2020, but bank stocks are usually the backbone of the U.S. economy.
5. Auto loan delinquencies surge
If there’s one specific lending aspect to worry about, it’s auto loan delinquencies. Although the total number of auto loans outstanding pales in comparison to the dollar amount of mortgages outstanding, we entered 2020 with auto loan delinquencies at an eight-year high. This is to say that the auto loan market was already experiencing serious issues well before the coronavirus pandemic struck. If we were to see auto loan delinquencies extend beyond just subprime borrowers, banks could find themselves in pretty big trouble.
6. A shift in investor sentiment toward the FAANG stocks
The stock market could also plunge if investor sentiment were to shift on the FAANG stocks: Facebook, Apple (NASDAQ:AAPL), Amazon, Netflix, and Google, which is a subsidiary of Alphabet.
Without question, the FAANGs have led the market higher since the March 23 bottom. But it could just as easily be argued that their valuations are now less than appealing. Apple, in particular, is valued at more than 30 times next years’ earnings and is being treated like a services company, despite the fact that it’s only generated 19% of fiscal 2020 sales from higher-margin services. The last time Apple was valued so aggressively relative to its cash flow potential was more than 12 years ago, and it subsequently shed more than half of its value.
Suffice it to say, sentiment can shift at the drop of a pin on Wall Street.
7. The Fed runs out of firepower
Finally, it’s very possible we’ll see the stock market roll over when the Federal Reserve runs out of firepower, which in my view may have already happened.
The Fed has taken its federal funds rate as low as it’s willing to go, and has pledged unlimited quantitative easing to shore up the markets and keep long-term lending rates down. But there’s only so much the Fed can do, and fiscal policy has been at a standstill over ideological disagreements between Democrats and Republicans on Capitol Hill.
What to do if the stock market crashes again
All of these factors suggest a second stock market crash may be coming. Should another big downdraft arrive, running for the hills isn’t what you’ll want to do. Rather, consider making the following three moves.
Assess your investment theses
First of all, take the time to reassess your initial investment theses in the stocks you hold. In other words, walk back through the reasons you bought into a company in the first place and make sure those reasons still hold true. It should be noted that you don’t need the threat of a potential stock market crash as a motivator to do this. Examine your portfolio every so often and consider selling companies that have broken your initial investment thesis.
Have dry powder at the ready
Secondly, you’ll want to have cash at the ready to deploy during a stock market crash or correction. Keep in mind that there have been 38 corrections of at least 10% in the S&P 500 over the past 70 years, and every single one of these significant moves lower has eventually been erased by a bull market rally. As long as your intention is to stay invested for the long haul, having cash at the ready during a stock market crash is a beautiful thing.
Continue to add to your winners
Lastly, it’s an especially smart idea to use stock market crashes as opportunities to add to your winners. Though it can be tempting to average down on companies that have struggled, the fact is that winners usually keep winning. Target companies that have clear-cut and (hopefully) sustainable competitive advantages during periods of panic and heightened volatility.