To buy or not to buy; to sell or not to sell? Those are probably the two big questions that a Warren Buffet or Ray Dalio ask themselves the minute they catch up on the day’s news. And any time the major indices start to go down or the arrow flashes red, those who have invested thousands or millions of dollars in the stock market get churning stomachs. If you are an Economics, Business, or MBA student, you may have heard of the terms “price correction” and “stock market crash”. How can one read from the red and green tickers whether a crash or correction is looming?
There may be investors looking to buy stocks when their prices are trading lower than the previous day or week, knowing that the prices will eventually start to rise again. On the other hand, the major markets are always in a panic when the red ticker is on a persistent downward spiral, and everybody starts to sell. That’s where an investor like Mr. Buffet swoops in and buys everything for the cheap. This strategy has effectively allowed him to retain his spot on the top percentile of the world’s 1 percent.
The current pandemic has caused major concerns about the survival of companies consistently on the red side of the ticker for months on end. Yet, we also hear news about how the world’s billionaires are making more money in a day than they ever made before. For example, Amazon (AMZN: NASDAQ) had its biggest drop in share price in March due to fears of the pandemic. The world’s richest man effectively dropped about $18B in paper wealth in a single month. Yet in July, Jeff Bezos added almost $13B to his wealth in a single day! What’s this absurdity?
The importance of these two concepts is important for economics or business students who may inevitably be forced to write a paper on how the economic machine works. If you’re thinking, “how do I write my essay if I can barely discern between crashes and correction?” – this article will be a great asset.
Stock Market Correction in Markets Gone Mad
One would argue that stock such as Tesla’s is ridiculously high for a company that has started making profits just a few years ago. Tesla (TSLA: NASDAQ) has almost quadrupled in value since March to about $290B. That is a mind-boggling figure that makes the automaker the most valuable car company in the world, higher than the three top-selling automakers in the world combined. Never mind that of the 90 million vehicles sold worldwide in 2019, Tesla sold less than 370,000.
As an investor who has a retirement account, would it be a good idea to direct this long term investment to Tesla with its price volatility? On the other hand, short term investors will always be looking to jump on such stocks because they can make a quick kill in a fairly short amount of time. Eventually, the bubble does burst, and the stock prices of companies such as Amazon and Tesla start to drop or remain fairly constant.
Companies such as Microsoft and Oracle have already gone through the correction process, thus keeping the stock price out of reach for the majority of new investors, and the wealth of their investors fairly constant.
A Looming Stock Market Crash | The Tell-Tale Signs
The last time that there was a stock market crash was during the 2009 Financial Crisis. This was widespread; markets all over the world were screaming bloody murder. Vast layoffs, bankruptcies, huge government borrowing to fund economic stimulus, and high profile resignations are all after-effects of a crash. But how can you tell when it is coming?
For one, a price correction may be highly limited to a particular trading market or one stock in particular, in this case, Tesla or Amazon. A crash, on the other hand, is a monetary tsunami, with ripple effects across global markets, from Shanghai to London and on to New York. Many economists argue that one of the signs of an impending market crash is when stock prices reach record levels, as we are witnessing in 2020.
In this case, prices have not only surged, but they are sort of overheating to unprecedented levels. The trillions of dollars invested in these markets not only come from private or single investors but also government entities and sovereign wealth schemes. If it all tumbles down, the fall is inevitably intertwined and will be felt widely.
An inverted yield curve is another good indicator of a looming crash, and economics students should learn this concept. This where investors in government securities are willing to accept a lower long-term yield (say 5-10 years) than higher shorter-term yields say a month to a year. This could signal hedging and lack of confidence in the current state of the stock market since government securities are backed.
We hope that you’ve learned the differences between crashes and corrections are now in a position to tackle your essay or research paper. And if you are an investor, just keep in mind that the best stocks are always available for the cheap after a crash or correction; therefore, these are usually the best times to invest.