How likely is the world to witness the next financial crash in 2019/2020?
When we speak about the future direction of the stock market, we are always guessing
We really don’t know with any confidence or certainty what will happen to the markets in 2019/20, we may have a feeling, based on the news articles we read, but if we read a different set of articles we’d have a different outlook about the market direction.
This was evident in 2007/08 when nobody that I am aware of predicted the market top, but there were many who came forward after the event explaining their methods, hindsight is a wonderful thing and it sells well!
At present we may be concerned with Brexit and Trumps trade tariff with China, but if a deal is agreed and Trump relaxes the tariffs, it will be a different storey.
Markets are generally rational and fairly priced, but on occasions, they do crazy things. Are they going to correct next year, I don’t know and nobody does with any certainty, but rather than worrying about something you cannot control, like the short-term direction of the market, focus instead on what you can control, like your asset-allocation.
You should ensure your asset mix between equities and high-quality short-medium term bonds is right, the lower your risk tolerance and the closer to when you need access to your capital, the higher your allocation to these types of bonds should be.
For retirement funds, as a general rule of thumb, you can use 100 minus your age for your equity allocation, so a 20-year-old who has a long time until the retirement funds will be needed, say 40-45 years, would have 80% in equities (100 minus 20) may work. Whereas a 70-year-old would have 30% in equities, still maintaining an exposure to provide some growth. Having such a high allocation to these bond funds should reduce the overall volatility of the portfolio.
Secondly, look at your funds and consider moving from active managed funds to index tracker funds. This is likely to do three things for your portfolio, firstly and most importantly, it should reduce your costs, so you keep more of your gains, secondly it removes the fund managers emotion from your investment performance, fund managers are also human and are affected by market turbulence and finally, you may find that a global index fund holds more shares across more countries so provides you with more diversification.
What would happen? How would markets react?
2000 and 2007 were very much market extremes and these significant retracements were for different reasons and I am not convinced that we are in a position like this today.
What would be the main contributing factors to this? Trade war between the US and China, rising interest rates, etc.
Stock markets are forward pricing machines and they like to know what will happen in the future, although stock market valuations are not wildly high, we have global challenges, like Brexit, Trumps trade tariffs with China and global populism all of these cause market uncertainty this is likely to reflect in the volatility we are experiencing and market retracements.
How long would it take to recover?
Since 1986 the FTSE 100 has had 8 negative years out of 31 years, it’s the negative years that are more concerning for us as we see out investments fall. Markets generally fall quicker, but less often, than they grow, this causes fear.
The FTSE 100 has averaged just over 9% over since 1986, but some years were negative, the worst being over 32% fall (Nov 2007 to Oct 2008).
How long they take to recover will depend on how far the retracement is and what the global central banks do. If we look at previous events about three years. That’s why financial planners suggest only investing in the stock market if you have at least five years, preferably seven years until you need access to your capital. If you have less than five years, you should consider deposit accounts and National Savings & Investment products.
How can the world prepare for the next financial crash?
Asset allocation, asset allocation, asset allocation. Get this right, globally diversify and only use short-medium term high quality bonds and focus on what you can control.