Are we staring right past the signals of a possible stock market crash in all this bullish euphoria? Are the big market corrections lurking around the corner? These are a few questions every other investor in the stock market is curious about.
What is stock market crash?
The stock market crash meaning is simple. When there is a rapid and unpredicted drop in the value of major stock prices due to economic crises, political instability, bursting of a financial bubble, or any disastrous event, it is called the stock market crash.
The March 2020 stock market drop was in the wake of the COVID-19 pandemic. The global market faced a crash due to fear of the great recession. Sensex and Nifty faced the biggest loss since October 2008 crash. But the market recovery was as stunning as its march 2020 fall. Within a year, Sensex and Nifty not only covered their losses but doubled from the March lows. Since then the US and Indian markets are on a bull run.
Seeing the historic patterns, the bull run does not seem to last long. Eventually, the market corrections take place sweeping away the investor’s wealth. The growth of the Indian stock market of tremendous as compared to any other global market.
The consumer is the driving force behind any market. As the consumer spends more, the profits of companies increase and thus their stock price. Eventually, the investors pump more money into the market. How to know the stock market going to crash? The market shows various signals to indicate an upcoming stock crash.
Foreign Institutional Investors:
We should look into the reasons for the bull run in Indian Markets. One of them is Foreign Institutional Investment (FII) in 2021. The markets were pumped with a record-breaking $ 3.7.6 billion FII inflow this year. One of the reasons behind jaw-dropping FII is the monetary policy of the United States Federal Reserve Bank. The low-interest rates of 0.25% and inflation of around 2.5% in the US economy have drawn investors towards developing markets. They have invested heavily in Indian start-ups as well. The demands by FIIs have surged the markets to their soaring highs.
But the Fed’s Monetary policy may not remain the same for a long time and the Foreign Institutional Investors may withdraw their investments that may cause the next share market crash.
The most famous financial bubble burst happened in the early 2000s. Before the ultimate burst of the bubble, the Nasdaq index increased five folds. The index was dominated by internet-based stocks. Investors crazily invested in stocks of any company which promised an online business. The price of the equities of such companies grew exponentially while they were unprofitable. Soon the bull run saw its peak and the Nasdaq index saw a huge crash facing a 76% fall in its value on 4th October 2002.
Similar trends could be seen now. As the bull run continues, investors and analysts fear that this might be a market bubble that will soon find its peak and eventually burst.
The basic indicator which dictates the valuation of a stock or index is its Price- Earning Ratio. This ratio compares the share price to the profits earned by the company. Ideally, the stock price should be indicating the growth and profitability of a company. But this is hardly the case most of the time. Here, the P/E ratio is the most important tool as it is helpful to determine whether the stock is undervalued or overvalued. A high P/E ratio is a red alert. In the bull run of 2007-08, the Sensex has a P/E ratio of 22, which was followed by a crash in October 2008. Now the Sensex has a P/E of around 31. This shows the market is overvalued.
It is said that the stock market is the reflection of the economic conditions in a country. But, let’s look at the 1991 Sensex. The market was in a bull run even when the country was facing the worst economic crises! Soon, the market saw a historic crash in 1992 with exposure of Harshad Mehta Scam.
Today, the market is flooded with new investors as the wake of the pandemic also saw the opening up of multiple Demat Accounts. The bull run is causing many impatient investors to invest blinded by sentiments rather than Fundamental Technical Analysis.