Today the SP index of stocks closed at 2907, very close to the all-time high of 2940. It is tempting to wrongly leap to the conclusion that the ten year old economic cycle will never go into a recession and thus stock prices will grow infinitely upward.
Junk bonds and similar junk quality loan assets continue to rise in price, implying the market thinks no crash is coming. As junk bond prices rise this makes their interest rate lower and thus attracts more borrowers, thus stimulating the economy. I have for a long time advocated that the tipping point in flipping over into a recession is the reduction of the availability of cheap, plentiful junk financing. If the supply of junk financing is turned off then the economy tips into recession. As the economic cycle gets older more shaky businesses may fail, but if they can get a new, bigger junk loan to pay their bills they can keep their unprofitable business from closing, thus preventing a recession. The failure rate for small new business is roughly 70% to 90%. The average life of a public company has gone from 75 years to 17 years in the past 60 years, thus the economy is more sensitive to a sudden trigger point that could lead to recession.
The crash of 2008 started with the failure of obscure subprime shadow banks in early 2007. On August, 2007 the massive failure of Northern Rock bank (not a shadow lender, but a bank) became the tipping point where global credit market investors realized something was wrong with junk quality lending so they tightened their supply of funds to the junk loan industry.
The current cycle has had an unprecedented experience of globally coordinated central bank Quantitative Easing that has pushed junk lending rates down to near 3% yield for the ICE BAML index in Europe. At some point investors will get tired of too many defaults in junk bonds and they will tighten up, closing down the flow of new funds to this asset class. This happened during the 4Q2014 oil industry crash that hurt that industry. It could happen at random to a cluster of weak companies where random spurt of excessive losses could trigger investor panic leading to a shutdown of the junk lending industry. This, in turn, could trigger recession.
Even with no recession, stocks are overpriced with a PE10 ratio double what is reasonable. Thus ultimately stock prices will come down whether spurred on by recession or simply because investors wake up and realize prices are too high.
Investors need independent financial advice about the risks of a sudden recession leading to a stock crash.