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Opinion: Factors aligning for a significant stock market decline. Here’s why investors should remain calm.

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The looming question on many minds is when the next stock market crash will take place. In the past, stock market crashes have been rare events that occur when certain elements align, making a crash unlikely in the near future. However, it is always helpful to examine the factors that could lead to a crash.

One key element is a frothy stock market, which often precedes a crash. Historical crashes, such as the Panic of 1907 and the crash of 1929, occurred after significant market rallies. More recently, the S&P 500’s substantial gains in 1987 were followed by the largest crash in history. Currently, the S&P 500 has rallied 140% since March 2020, with a forward price-to-earnings ratio at a level not seen since 2001.

Rising interest rates have also been a factor in past crashes. When the Federal Reserve pushed rates higher in the mid-2000s, it made stocks less attractive compared to risk-free T-bills. While interest rates have stopped climbing, the yield on the 10-year Treasury has quadrupled over the last three years, signaling potential concerns.

Another factor contributing to crashes is the emergence of new financial mechanisms that introduce leverage. In past crashes, these included portfolio insurance in 1987 and mortgage-backed securities in 2008. Currently, the private credit market, where hedge funds act as lenders, poses a potential risk due to its size, complexity, and lack of oversight.

While the elements for a crash may be aligning, it does not guarantee its inevitability. Investors should focus on maintaining a diversified portfolio, avoiding speculative bets on a crash, and sticking to their long-term investment plans. History has shown that stock market crashes can present buying opportunities, and staying invested in the American stock market remains a wise decision in the long run.

As uncertainties linger regarding a potential crash, investors should prioritize prudent financial decisions and remain vigilant. By understanding the historical context of past crashes and taking appropriate precautions, investors can navigate potential market downturns with confidence. The key is to remain informed, adaptable, and disciplined in the face of market volatility, ensuring a secure financial future.

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