Jeremy Grantham of GMO published a document at gmo.com on Jan. 3, 2018 that the SP needs to go to 3,400 to 3,700 to be high enough to have a crash. First a melt-up (where stocks go up far too fast) is needed to lead to a crash. The big stock price increase of 2019 implies that a melt-up has occurred.
The idea would be a 60% increase from the 2,100 level in mid-2017 until it reached 3,400 in 21 months. In actuality it took over 30 months to climb nearly 60%. If a bubble is too modest and gentle then apparently it is less likely to crash. Recently the SP reached 3338. It dropped 1% today. Grantham mentioned a period of 6 to 24 months before the bubble maxes out and then goes down.
Perhaps soon problems like the impeachment trial, the primaries elections, and the China trade deal details will be resolved in a way that is deemed by investors to be helpful to the business community and to stock prices, thus pushing the bubble up even higher in the next few months before the crash finally comes. Usually a year with huge gains like 2019 is followed by a year where stocks decline.
A PE10 ratio of 34 (fair value should be about 15) is far too high to invest in. Trying to play the momentum game of buying overpriced stock so as to quickly sell at an even higher price (The Greater Fool theory) is very risky as the market could crash 22% in a day and then not go back up. Even though the stock exchange has circuit breaker Trading Curb (Rule 80B) rules, eventually if the market needs to go down a lot the market will go down by simply waiting until the circuit breaker delays have lapsed. A level three trading curb on the NYSE would result in no trading for the rest of the day. So what, the market could continue downward the next day until it reached equilibrium.
If too many people play the momentum game of buying overpriced stock then eventually they will encounter a sharp, steep crash from which they may not recover.
In modern times many bullish investors have sold (to issue) unhedged put options. Sometimes these don’t “knock-in” until the underlying stock dropped 30%. Thus a 29% drop may be viewed by the investor as no worse than a zero percent drop, since he incurs no loss until it breaches 30%. But if suddenly the 30% barrier is breached that could result in a catastrophic panic by bulls who suddenly wake up to the danger and then rush to liquidate positions. Thus a repeat of the 10-19-1987 down in 22% one day crash could happen.
Investors need independent financial advice about the risks of a melt-up followed but a deep crash.