Hi DeepSeek,
How high is the likelihood of a stockmarket crash in the USA?
The soaring gold price, Buffett Indicator, Price/Earning ratio,
Price/Sales ratio and mean price reversion have all flashed red
before past crashes, but rarely all at the same time.
Today, they’re all flashing red. Valuations have drifted far
beyond what the companies' earnings, corporations' revenues or
the US economy can realistically support. Will a crash in the
USA spread to New Zealand?
Summary
-
USA: The
likelihood of a significant market downturn is
high based on valuation metrics. The environment
is one of elevated risk. It's not a question of
if a
stock price
reversion will happen, but when and how
violently.
-
New
Zealand: New
Zealand would not be immune. It is highly
susceptible to any US-led global downturn
through financial, economic, and psychological
channels. A US crash would almost certainly lead
to a sharp fall in the NZ market and pose
significant risks to the broader New Zealand
economy.
This
reminds us of the importance of having a well-diversified
portfolio and a risk tolerance that can withstand
significant market volatility.
Part 1: The Likelihood of
a Stock Market Crash in the USA
The
Case
for High Risk (The "Red Flags")
- The Buffett Indicator (Total Market Cap to
GDP): This
is well into "significantly overvalued"
territory, historically a strong predictor of
low long-term returns.
- Elevated P/E Ratios: Whether
looking at the Shiller CAPE (Cyclically
Adjusted P/E) or trailing P/E for the S&P
500, valuations are high compared to
historical averages, suggesting future
earnings growth is already priced in.
- >Mean Reversion: This
is the powerful force you mentioned. Markets
have a long-term tendency to revert to their
historical mean valuations. After a long
bull market, the reversion can be sharp and
painful.
- Concentration Risk: The
market's performance has been heavily reliant
on a small group of giant technology stocks
(the "Magnificent Seven" etc.). If their
momentum stalls, it can drag down the entire
index.
- "Higher for Longer" Interest Rates:The
Federal Reserve's battle against inflation has led to
interest rates not seen in decades. This makes borrowing
more expensive for companies, reduces the present value of
future earnings (making stocks less attractive relative to
bonds), and cools down the economy.
The
Counter-Argument (Why a "Crash" Isn't a Certainty)
- Artificial Intelligence (AI) Optimism:Proponents
argue that we are in a new technological paradigm. The
potential productivity gains from AI could justify higher
valuations if they lead to a significant surge in earnings
growth in the future. The market is betting on this
future.
-
Corporate
Profit Resilience: Despite
headwinds, corporate earnings have remained
relatively strong overall. A strong labor
market has so far helped the economy avoid a
recession.
-
The
"TINA" Argument ("There Is No
Alternative"): While
bonds now offer decent yields, the equity
market has been the primary engine for
wealth creation for over a decade. This can
create a behavioral bias to stay invested.
-
The
Fed's "Put": Many
investors believe the Federal Reserve would
intervene to support markets if a downturn
threatened to cause a systemic financial
crisis, limiting the downside.
Conclusion on US Likelihood:
It
is
more accurate to say the probability
of
a major correction or a bear market is high,
rather than predicting a specific "crash" (e.g.,
a 20%+ drop in a short period). The conditions
are ripe for a significant downturn. The key
triggers would likely be:
• A recession finally
materializing.
• Earnings disappointing
relative to high expectations.
• A geopolitical shock.
• A crisis of confidence in
the tech giants.
The
metrics
you listed suggest that the risk/reward
profile
for US stocks is very poor from a long-term
perspective. While
a
crash is not guaranteed, the
market is priced for perfection, and any
stumble could lead to a sharp decline.
Part
2:
Will a Crash in the USA Spread to New
Zealand?
The short answer is: almost certainly yes.
New
Zealand's
financial markets are highly integrated with
global markets, and the US market is the
world's largest and most influential. Here’s
how a US crash would transmit to New
Zealand:
- Psychological
Contagion (Risk-Off Mode): A
US crash creates global fear and a
"risk-off" sentiment. Investors worldwide
sell risky assets (like stocks) and move to
safe havens (like government bonds, gold, or
the US dollar). This selling pressure would
hit the NZX (New Zealand's stock exchange)
directly.
- Economic
Linkages:
* China Connection: New
Zealand's economy is heavily dependent on
exports, particularly to China (dairy, meat,
timber). A US recession would likely slow the
global economy, reducing demand from China for
New Zealand's commodities. This would hurt
NZ's corporate earnings and economy.
*
Tourism: A
US/world recession would reduce international
travel, impacting New Zealand's vital tourism
industry.
- Financial System Linkages: New
Zealand banks source a significant portion of
their funding from international markets. A
global financial shock could make this funding
more expensive and scarce, tightening credit
conditions within New Zealand.
- Currency Volatility: In
a panic, investors often buy US dollars. This
could cause the NZD to fall sharply against
the USD. While this helps exporters, it
increases the cost of imports (fuel,
electronics) and can fuel inflation.
Potential
Mitigating
Factors for New Zealand:
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