Is a Stock Market Crash Looming? Here’s What the Data Says You Should

For the past year and a half, investors have been privy to the greatest bounce back from a bear-market bottom in history. It took less than 17 months for the benchmark S&P 500 (SNPINDEX:^GSPC) to double after shedding a third of its value in a month during the initial wave of the coronavirus pandemic.

But this perfect march higher may be encountering trouble.

This past Monday, Sept. 20, the S&P 500 suffered its worst single-session loss since May. Could this mark a turning of the tide for the broader market or even a stock market crash? Here’s what the data suggests could happen, as well as what you should do in response to these concerns.

Image source: Getty Images.

The case for double-digit downside in the stock market is building

Before I dive into the data, let’s get one very important tidbit of information out of the way. It’s absolutely impossible to predict with any preciseness when a stock market crash or correction will occur, how steep it’ll be, or how long it’ll last. With this being said, there are a growing number of warning signs that double-digit percentage downside is brewing.

To begin with, the S&P 500 has an uncanny track record of falling significantly when valuations get really extended, as they are now. Over the last 151 years, the S&P 500’s Shiller price-to-earnings (P/E) ratio has surpassed and held past 30 on five separate occasions, including now (Shiller P/E of 36.7, as of Sept. 21). The Shiller P/E examines inflation-adjusted earnings over the past 10 years. In the previous four instances where the Shiller P/E topped 30, the index subsequently fell by a minimum of 20%.

Margin debt is another clear worry. Margin debt describes the amount of money borrowed by investors with interest to buy or short-sell securities. While it’s not abnormal to see nominal margin debt outstanding rise over time, it is unusual for margin debt outstanding to climb 60% or more in a single year. Over the past quarter of a century it’s only happened three times: Directly before the dot-com bubble burst, directly before the Great Recession, and in 2021. A cascade of margin calls could be very bad news for the broader market.

History isn’t the market’s friend, either, at least in the very short term. When we look back at how the S&P 500 responded following each of its previous eight bear markets, dating back to 1960, we see that it underwent one or two declines of at least 10% within the first 36 months following a bear-market bottom. In other words, bouncing back from a recession or fear-induced event is a process that has bumps in the road. After 18 months, we’ve not had any bumps in the road.

Image source: Getty Images.

History is actually one of investors’ greatest allies

Even though history would seem to suggest that the S&P 500 could find itself in some trouble here sooner than later, history is also one of investors’ best friends.

Since 1950, the benchmark S&P 500 has undergone 38 double-digit…