As I wrote in a previous post, there have been three bull markets since World War II that lasted longer than 5 years. Two of the three ended in crashes – 1987 and the 2008/9 financial crisis we all just suffered through. While it is entirely possible that this time will be different, and we could see stocks push ahead, driving a sixth year of positive gains, it is far more likely that this year will be a down year. The problem is that year 6 performance for bull markets tends to be very extreme – either the market does incredibly well, or just plain awful.
On Black Monday, October 19, 1987, stock markets around the world crashed, beginning in Hong Kong and spreading west to Europe, hitting the United States after other markets had already declined by a significant margin. The Dow Jones Industrial Average dropped by 508 points to 1738.74 (22.61%). The S&P 500 lost 28.5% of its value between October 14 and 19. The total loss of wealth over that period was approximately $1 trillion, according to a Presidential Task Force report on the crash.
Given the magnitude of the gains over the past 5 years – 180% for the S&P 500 – and the increased volatility we have experienced due to a number of factors including the globalization of financial markets, the growing size of our economy and stock market value, the increased number of small investors actively involved in the stock market, etc., it is highly likely that if we were to have a 1987-style crash, the percentage drop could be even larger than what we experienced in October of 1987.
If stocks crash by 30%, which is certainly within the realm of probability, not just possibility, given the current age of the bull market and the valuation of the market, we would see the S&P 500 fall to around 1,300. Looking at technical support levels and trading history in the 1,300 area of the chart, should the S&P 500 fall to 1,300, it is likely that stocks would fall a bit lower, landing on support around the 1,200 to 1,250 level.
A drop for stocks of this magnitude, at least in the short-run, would be very damaging to the U.S. economy, and would certainly spark a global financial market sell-off of huge proportions. However, for those able to take advantage of the drop in stocks, the long-term opportunities will be plentiful and potentially highly profitable.