Is a stock market crash looming? Here’s what the data says you should focus on
For the past year and a half, investors have known about the biggest rebound in history from a bear market. It took less than 17 months for the benchmark S&P 500 (SNPINDEX: ^ GSPC) to double after losing a third of its value in a month during the first wave of the coronavirus pandemic.
But this perfect upward march can run into problems.
On Monday, September 20, the S&P 500 suffered its worst single-session loss since May. Could this mark a trend reversal for the broader market or even a stock market crash? Here’s what the data suggests it could happen, as well as what you should do in response to those concerns.
The case for a double-digit stock market decline grows stronger
Before we dive into the data, let’s eliminate some very important information. It is absolutely impossible to accurately predict when a stock market crash or correction will occur, how steep it will be, or how long it will last. That being said, there are a growing number of warning signs that a double-digit percentage decline is brewing.
For starters, the S&P 500 has an odd history of significant drops when valuations really lengthen, as they do now. Over the past 151 years, the S&P 500 Shiller price / earnings (P / E) ratio has exceeded and held above the 30 on five occasions, including now (Shiller P / E of 36.7, to September 21). The Shiller P / E examines inflation-adjusted earnings over the past 10 years. In the previous four instances where the Shiller P / E exceeded 30, the index then fell by at least 20%.
Another obvious concern is margin debt. Margin debt describes the amount of money borrowed by investors with an interest in buying or selling short securities. While it is not abnormal to see the outstanding nominal margin debt increase over time, it is unusual for the outstanding margin debt to increase by 60% or more in a single year. In the past quarter century, this has only happened three times: just before the dot-com bubble burst, just before the Great Recession and in 2021. A cascade of margin calls could be very bad news for the market at large.
History is not the friend of the market either, at least in the very short term. When we look at how the S&P 500 reacted after each of its previous eight bear markets, dating back to 1960, we see that it has suffered one or two declines of at least 10% in the first 36 months following a market bottom. bearish. In other words, recovering from a recession or fear-provoked event is a process that faces obstacles. After 18 months, we had no problems on the road.
History is, in fact, one of investors’ greatest allies.
Even though history seems to suggest that the S&P 500 could find itself in trouble here sooner rather than later, history is also an investor’s best friend.
Since 1950, the benchmark S&P 500 has suffered 38 double-digit declines. Each of those declines was ultimately put in the mirror by a bullish market rally. In other words, every crash or fix in history has been a buying opportunity, as long as your investment timeline is measured in years, not days, weeks, or months.
Another thing to note about double-digit declines in the S&P 500 is that most don’t last very long. The average time it took for the S&P 500 to go from peak to trough of 38 crashes and fixes since 1950 is 188 days. It’s been about six months. During this time, the market has spent much more time in bullish mode.
Want further proof that time and history are on the investor’s side? Earlier this year, Crestmont Research released a report showing that the 20-year S&P 500 rolling total returns (including dividend payouts) were never negative between 1919 and 2020. That means if you look at 102 end years between 1919 and 2020, the 20-year rolling average annual total return would have been positive.
The story is pretty clear when it comes to crashes and fixes: long-term investors should buy, not run for the hills.
Three perfect examples of stocks to buy in the event of a crash
With the long-term data unquestionably favoring the bullish, here is a trio of stocks to consider buying if Monday’s larger-than-normal pullback turns into a full-blown correction or even a crash.
For Growth Equity Investors, the Backbone of Social Media Facebook (NASDAQ: FB) is an incredibly solid addition during double-digit market declines. Facebook ended June with a hair’s breadth north of 3.5 billion monthly active users. That’s about 44% of the world’s population visiting an asset held each month. Advertisers are fully aware that there is no other platform on the planet that will give them more looks for their post than Facebook, which gives the company such impressive ad pricing power.
Plus, Facebook isn’t even close to monetizing all of its assets yet. Although it generates advertising revenue from Instagram and its eponymous site, Facebook Messenger and WhatsApp, which are two of the most visited platforms in the world, have not been significantly monetized.
Don’t overlook Facebook’s Oculus devices, either. Facebook aims to become the leader in virtual reality, which is expected to be one of the fastest growing trends of the decade.
Value equity investors should consider buying a drugstore chain CVS Health (NYSE: CVS) on any big dip in the larger market. Since people don’t have a choice of when to get sick or what condition (s) they develop, the demand for prescription services tends to be fairly stable no matter how the stock market performs.
What separates CVS from much of its competition is the vertical expansion of the company. Rather than buying more pharmacies, CVS acquired health insurer Aetna in late 2018. Aetna’s health insurance operations are driving CVS ‘organic growth rate and giving more than 20 million members Aetna a reason to stay in the CVS Health pharmacy ecosystem.
CVS is also attracting customers locally by opening up to 1,500 HealthHUB health clinics in the United States. These clinics aim to put chronic care patients in contact with doctors or specialists.
CVS shares are more than 10 times expected earnings per share in 2021.
Want value and income? Actions of leading regional banks US Bancorp (NYSE: USB) would be the ideal stock to buy during a crash or correction. The stocks can currently be recovered for about 11 times the expected earnings this year, and they are returning a 3.3% return, the best in the market.
One of the reasons that US Bancorp is consistently one of the best banks, as measured by its superior return on assets, is its avoidance of riskier derivative investment opportunities. Focusing on growing loans and deposits has never been a sexy aspect of banking, but it has helped US Bancorp avoid adding time bombs to its loan portfolio. That’s why it rebounds from recessions faster than its peers.
Another reason US Bancorp stands out is its aggressive digital investments. Few, if any, customers have embraced digital banking services with open arms, as have customers of US Bank (US Bancorp is the parent company of US Bank). As more consumers turn to online or mobile banking than ever before, US Bancorp is able to consolidate branches and lower non-interest costs.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.