Watch these stock market risk factors.
The S&P 500 is on a seven-month winning streak and hasn't had even one 5% pullback so far in 2021. The stock market is showing signs of weakness so far in September, however, including stringing together five consecutive down days. The S&P 500 more than doubled after its March 2020 lows in less than a year and a half, but there are several factors suggesting that the next market crash could be just around the corner. Here are 10 catalysts that could trigger an S&P 500 sell-off, according to DataTrek Research.
For whatever reason, September has historically been the worst month for the S&P 500 by a wide margin. Since 1928, the S&P 500 has averaged a 1% loss in September. The only other months with negative average returns are February and May at -0.1% each. In fact, September is the only month that has had more down years (50) than up years (42). Last year was certainly no exception. In the middle of an strong bull market rally, the S&P 500 experienced a nearly 10% correction in September 2020.
DataTrek Research co-founder Nicholas Colas says unexpected geopolitical events are always a risk for investors. One of the most significant examples of this type of event in recent decades happened in September. The S&P 500 dropped 14% in its first week of trading following the terrorist attack on Sept. 11, 2001. These geopolitical events can be nearly impossible to predict, but Colas says anything that threatens consumer and small investor confidence is a potential threat to the stock market. For now, Colas says he's watching China and Afghanistan as potential sources of negative geopolitical headlines.
There have been several oil shocks in recent decades that have negatively affected the stock market to varying degrees. The Saudi oil embargo in 1973 created temporary U.S. shortages. Iran's Islamic Revolution in 1979 and the first Gulf War in 1991 each caused oil prices to double. Oil prices as high as $140 per barrel even contributed to the economic crisis in 2008. Colas says oil shocks have caused more recessions than any other catalyst over the past 50 years. The price of WTI crude oil is already up about 80% in the past year.
When considering the trigger for the next stock market crash, it makes sense to look back at what caused the previous one. From its mid-February 2020 high to its bottom on March 23, the S&P 500 dropped about 37% due to panic over the spread of COVID-19. Today, the world is fortunate enough to have multiple effective vaccines against the virus, but the delta variant of COVID-19 is still spreading rapidly and pressuring hospitals. If the outbreak worsens or a new, vaccine-resistant variant necessitates a return to economic shutdowns, investors could be in for a repeat of March 2020.
Since the second quarter of 2020, S&P 500 earnings have beaten consensus analyst expectations by an average of 19%. That recent earnings upside far exceeds the S&P 500's 2% average quarterly earnings beat from 2000 to 2019, according to Bank of America. Colas says analyst estimates for full-year 2021 S&P 500 earnings are up 20% since the start of the year from $167 to $201 per share. It's likely not a coincidence that the S&P 500 is also up about 20% year to date, an indication of just how important third-quarter earnings season could be for stock prices.
Colas says there are countless potential sources of negative political news in the near term. Congress could fail to reach an infrastructure spending bill compromise. The Federal Reserve could mistime comments or actions on bond purchasing and interest rate hikes. President Joe Biden has proposed raising the corporate tax rate from 21% to 28%, which would negatively affect earnings. Treasury Secretary Janet Yellen even recently issued a warning to Congress that the U.S. is approaching a potentially historic default that could cause "irreparable damage to the U.S. economy" should Congress fail to raise the U.S. debt ceiling by mid-October.
Chinese economic slowdown
While the U.S. has plenty of near-term economic hurdles at home, Colas says investors should also keep an eye on China. In August, Goldman Sachs, Morgan Stanley, Nomura and other investment banks cut their full-year gross domestic product growth estimates for China following a round of disappointing economic numbers suggesting China's economic recovery is slowing. China has also been hurting its own stock market by cracking down on domestic tech stocks. Finally, Colas says China has taken an aggressive approach to pandemic lockdowns up to this point, so any fall or winter outbreaks could cause further economic disruptions.
Inflation has been a major topic of debate on Wall Street this year. The most recent monthly consumer price index reading indicated 5.4% inflation compared with a year ago -- the largest year-over-year increase since 2008. Fed Chair Jerome Powell has been adamant that elevated inflation levels are merely "transitory" as the economy opens back up to full capacity. At this point, Colas says easy 2020 comparisons are largely responsible for elevated 2021 inflation readings, but he says the recent rapid rise in housing prices could have a larger effect on 2022 CPI readings than investors realize.
Big Tech regulation
Incredibly, Apple Inc. (ticker: AAPL), Microsoft Corp. (MSFT), Amazon.com Inc. (AMZN), Alphabet Inc. (GOOG, GOOGL) and Facebook Inc. (FB) account for around 23% of the entire S&P 500's market capitalization. Regulators and politicians have been calling out these tech behemoths for noncompetitive practices for years. Big Tech companies have even been hit with fines and threatened with breakups, but their stock prices keep on rising. Colas says Big Tech stocks have traded as if regulators are powerless to reduce their dominance. But if something changes to make politicians in Washington prioritize antitrust enforcement on tech companies, it could drag down the entire market.
The cryptocurrency market is now valued at more than $2 trillion. There has been a boom in new retail traders in the past two years, and Colas says many small, inexperienced traders hold cryptocurrency investments in the same trading app portfolios that they hold stocks. Colas says inexperienced investors typically follow a similar pattern in reacting to stress in the market. They tend to sell their relative portfolio winners and buy more of their losers. If cryptos crash again like they did in 2018, these investors may sell stocks to double down on crypto, potentially triggering a stock market crash.
10 risk factors that could trigger a stock market crash:
-- Seasonal weakness.
-- Geopolitical event.
-- Oil shock.
-- Economic lockdown.
-- Disappointing earnings.
-- Policy change.
-- Chinese economic slowdown.
-- Rising inflation.
-- Big Tech regulation.
-- Cryptocurrency crash.