Are Stocks Heading For A 2008 Style Crash?
Stocks plunged across the board last week. The Dow dropped 6.4%, the S&P 500 shed 6.5%, and Nasdaq gave up 5.3%. It was the worst week for the markets since October 2008.
Several negative events sent investors fleeing from stocks for the perceived safety of US Treasuries.
First off, it’s looking more and more likely Greece will be unable to avoid defaulting on its debt. And if they do default, many fear it will trigger a domino effect of defaults across Europe. Portugal, Italy, Ireland, and Spain are believed to be on the brink of default.
As if that scenario isn’t bad enough, there’s more…
A wave of European government defaults are expected to ignite a financial crisis among European banks. Many of Europe’s top banks have lent tons of money to the ailing European governments. If Greece defaults, we could see a run on European banks.
Of course, Europe’s woes aren’t limited to the old world alone.
Many US banks have lent billions of dollars to European governments. And a large number of US companies do a lot of business in Europe. If European countries start defaulting and Europe falls into recession, it will definitely hurt US banks and corporations.
The really scary part for investors is no one really knows the extent of the US banks’ exposure to a potential European financial crisis.
And that’s not all…
The US economy has its own problems.
For months, the Fed has been saying the flagging US economic recovery was just a temporary situation that would be resolved by the fourth quarter of this year. But after their two-day meeting last week, it became clear the Fed’s outlook has changed for the worse.
In his press conference following the meeting, Fed Chairman Bernanke said, “[t]here are significant downside risks to the economic outlook, including strains in global financial markets.” The inclusion of a single phrase – “significant downside risks” – spooked investors and the markets.
Nearly everyone is interpreting this shift in language as a signal the Fed no longer believes the US economic slowdown is merely temporary. It’s being viewed as an admission by the Fed that additional monetary policy will not be able to get the economy growing again.
What’s more, the Fed reinforced this opinion by choosing not to employ another round of quantitative easing. Many investors were hoping the Fed would unveil QE3 after the meeting. The hope was QE3 would spark a rally in the stock market like QE2 did last year.
But the Fed clearly chose not to go down the QE path at this time.
Instead, the Fed unveiled Operation Twist, a policy last used in the early 1960’s.
This policy involves the Fed selling $400 billion worth of short-term Treasuries and using the proceeds to buy longer-term Treasury bonds. The idea is to boost short-term interest rates while lowering long-term rates. The Fed hopes this will encourage people to borrow and invest more.
Unfortunately, investors were not impressed…
Hardly anyone believes interest rates need to move lower to spur borrowing and investment. After all, rates have been hovering near zero for the past three years. And many are concerned the policy will shrink bank profit margins while many are still struggling to recover from the US financial crisis.
Bottom line…
It’s very difficult to make a case for higher stock prices right now.
With Europe teetering on the edge of a financial crisis and recession, and the US slipping back into recession, we’re likely to see a flurry of downward revisions to corporate earnings estimates in the weeks ahead. This would put even more downward pressure on stock prices.
The big question on everyone’s minds now is if the market is heading for a crash a la 2008. In fact, fears of this type of crash occurring again are sending many investors to the sidelines. While I don’t think a crash is imminent, it would be prudent to purchase some protection in case it does happen.
If you haven’t already, you may want to add a broad-market inverse ETF to your portfolio. These ETFs increase in value as the broad market indices decline.
Two widely used broad-market inverse ETFs are ProShares Short S&P 500 (SH) and ProShares Short QQQ (PSQ). SH will profit from declines in the S&P 500. And PSQ will profit from declines in the Nasdaq 100.
If the markets’ plunge further from here, these ETFs would provide a nice hedge for your long positions. Don’t get burned by another 2008 style market crash. Grab these ETFs today!
Category: Stocks
