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In the Hollywood version of investing, the idea is to sell high and buy low, and sometimes people have managed to do this making fortunes or at least success amongst their peers. The problem as the US stock market gets into it's 8th a year of gains, and the world market seems to be caught up in this long bull market for stocks and the assets of all sorts, that attempt doesn't really work anymore. When bonds are as expensive as well as stocks, what do you sell if you want to get out of the stock market?
And if you do want to get out how do you know when, because markets have defied pessimists for years? Projections that markets will fall, earnings will fall, it will all come to a sticky end really haven't come true. So the big question for investors and for policymakers who are worried about the financial stability implications of another market rout, is what will make markets crash, are valuations enough, and if so when will that happen?
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If you look at a popular valuation measure, which compares how much the stock market is worth to average corporate profits over the previous 10 years, then the US stock market has only been this expensive twice in its history since 1881. That was just before the 1929 crash and at the peak of the dot-com bubble in 2000. The question though is, what is going to make this crash, because the economy's doing pretty well it's recovering.
And if you look around the world most economies are recovering. It's very hard to find a country in recession. Venezuela, well that's falling into crisis, but even the UK, which has voted for Brexit while the economy is still expected to grow this year and next year.
And that comes to the point about what is needed to cause a market crash? Sometimes you need something to go wrong. Goldman-Sachs have looks at the 13 bear markets, which we've had since the 1960s, and what happens is usually a recession happens, or prices start to rise very quickly and the central bank pushes up interest rates to cut off inflation and that causes a downturn.
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So evaluation isn't enough. What do people worry about? Talk to the pessimists and they focus on these building crushes, things which will make any eventual downturn much worse when it does arrive.
Corporate indebtedness, well that's been going up. And people have been used to low interest rates for so long that any sort of inflation shock, if that pushed up interest rates, people, well many businesses and consumers wouldn't really know how to react. So the crash may not be coming soon. It could go on for some time. But the question is, when it does arrive how dramatic is it going to be?