Why the Stock Market is Crashing

Understanding the reasons behind the Feb-March 2021 Markert Crash and how to use this opportunity.

This year has been unpredictable and only carries signs of positive hope coming from last year which caused the world to shut down as we know it. But unlike last year this year is seeing a major change in the financial sector and to reflect it we can see a shift in the stock market. Some of the major companies have been in free fall as stocks crash and reach new lows every week.

The stock market, in general, is not doing good and companies like Apple is down by 11%, Tesla is down by 25%, NIO is down by 36% these stocks have been reaching all-time highs last year and their fall is causing people to assume or fear that this is going to cause the worst market crash since the depression of 1929.

Let’s face it no one can predict when the next crash will happen or how long it will last for and the only thing we can do is try to assess the current situation and help prepare for what is to come. Anyone can make enough predictions and one of them is bound to be right but the best one would be to predict the reasons and the exact know-how of the crash so we can use the opportunity to buy stocks during the “DIP”.

These are the theories for the current crash that is happening so let us try and understand them to make reasonable choices and gather more information without panicking and selling at the low and eventually lose our savings.

1. The Super Debt Cycle

Every news article, Market guru, Hedge fund manager out there will be talking about this so let us try to understand what this factor is and how essential it is.

Roughly once about every 50-75 years this cycle happens and apparently we are at the end of one now. What is the super debt cycle? Imagine the economy represented by huge complex equations with a lot of different variables that economists are trying to figure out and understand but some of those variables are known and can be controlled by us like productivity which is measured by the GDP of a country (Gross Domestic Product), The National Debt which historically is at an all-time high in the USA due to the previous year and the pandemic, The Interest Rate which is at an all-time low historically in the USA but this variable can be controlled by the central banks by lowering the interest rates you help the economy grow because you can encourage people to go and borrow money and which will lead to people spending more money in living and investing which increases the flow of money into the economy.

There is a limit as to how far a countries interest can be lowered before the variable is out of control and no longer has any effect on the economy when this factor is combined with other factors it is said that we are nearing or entering the aforementioned “Super Debt Cycle.” What this really means is that the last time we had the end of the super debt cycle was after the 2nd World War and the “Bretton Woods Agreement” was signed and a whole new monetary system was created where the USD (U.S Dollar) became the global reserve currency.

The last time such booms and burst happened in the market was 2008 during the housing market crash and 2020 due to the global pandemic which is more recent but if it is zoomed out and seen for the last 50 years we can see regular booms and crashes happening regularly in the market and the trend line, on the whole, has been upwards and that is the long term debt cycle.

This debt cycle does not always go up and eventually has to come down to balance out the growth as all things should be. This phase of the cycle coming down is what is known as the end of the cycle and this generally comes with the beginning of a new form of the credit system.

2. Central Bank Worries

This beginning of the credit system is what worries and spooks investors as they worry that central banks have lost control of helping the economy grow by just lowering the interest rate and this is a policy that has its limitations and letting the “money printer” run has no effects to benefit the economy and we need to find new ways to help the economy grow and fight the inflation that happened in 2020 and fight what this year's “glitch” as well.

That is where this year's potential fear of interest rate tightening of monetary policy begins and a tighter monetary policy means higher interest rates which tend to increase the rates of bonds which scares people away from the stock market that leads to the fall of the market.

Thus all of this growth which has been lead by monetary expansion for decades and decades makes people believe that at some point this long-term debt cycle has to come to an end and this debt will have to be repaid. As investors in the market we the “retail investors” have to look at what is called the risk premia.

3. Risk Premia

Risk premium or “Risk Premia” is a fancy term for what is known as assessing the risks of our investments i.e while we invest in the market we need to weigh our options between risky v/s non-risky assets. If we own stocks and hold cash then we will need to weigh the risks of holding both and check if the ROI (Return on Investment) is worthy so we can hold the investment.

This is where the current bond market comes into play as investors fear with the increase in bond rates ie yield Investors feel holding bonds is much less risky compared to holding stocks thus they leave the stock market leading to a dip in the market where stocks are in a free fall.

Since the risk is weighed and consumers and investors are satisfied with a gurateed return in bonds they continue to invest in recovery stocks and bonds which lets the tech sector to drop.

This is how risk permia effects the investment strategies.

4.Bond Yeilds and Inflation

Global research and investors believe that bonds are the way to go because of the way rate of return is guaranteed and this is because bond rates are almost at an all time high over the 10 year period and this increase in yield rate is a sign of positivity as covid-19's recovery, vaccination rates are steadily increasing which indicates a process where life is returning to “normal” thus people will spend more money as they leave isolation.

With the added news of the 2 trillion dollar coming to the public comes a fear of inflation where the scenario is the Federal reserves will start to sell of bonds it holds thus lead to an increase in yield to attract new investors as the value or purchase price of bonds goes down due to the sell-off from the largest bond holder the US Federal Reserve.

As fear of inflation goes up with the increase in bond yeilds its harder to borrow money as that comes with a rate of interest and this interest rate is going to grow along with bond yield rates so its a combination of all this factor which leads to an increase in the investor sell-off of stocks and purchase of bonds as a safer bet for a gurateed yield and thus fetch a decent ROI.

Conclusion

Since the technical stuff is explained and retail investors like us understand why the market is bloody and red we should try to use this opportunity as we should learn from investors like Cathie Wood,Warren Buffet and Michael Burry and not let market conditions dictate what we do and learn to buy high conviction stocks during the dip and try to get ahead of the curve.

This quote from Warren Buffet sums up what we should do in this bear market.

“Be fearful when others are greedy, and greedy when others are fearful.”- Warren Buffet