FINANCIAL CRASH TRACKING: PROTECT YOUR WEALTH AND INVESTMENTS FROM SECULAR DOWNTURNS

For the most part, as long term investors, we are invested in globally diversified funds and riding the 'market drift' up over the long term. So for the most part the equities market trends up. But even in up-trending markets, every single year there will be what is known as 'expected volatility' in equities.

An average year for the SP500 sees: -

• More that 7 separate 3% dips

• More than 3 separate 5% corrections

• A 10% correction, once a year

• A bear market (> 20% correction) every 3.5 years

Regardless of this volatility, most people's standard pensions will be invested in global equities and over the longer term this asset class will yield about 7% to 9% per year.  

The 3%, 5%, and 10% to 20% dips or corrections would not register on the longer term structural charts that I run through in this monthly video, but 20%+ corrections would be more likely to register and so these videos (based in this blog page) will act as a potential early warning signal.

EXPECTED VOLATILITY

Elsewhere in this blog I have explained how, as investors, we should not be overly interested in 'expected volatility' in markets over the shorter term. This is the handful of 3% to 6% pullbacks we will see every single year along with the one or two 8% to 15% every year to 2 years. Then we have the 'corrections' of about 20% say once every 2 or 3 years. You get the picture. These can be ignored without too much damage being done to long term portfolio's, but of course, the rubber hits the road when that nasty 20% correction keeps on going and morphs into the 40/50/60% correction (or worse!)

The chart below is the actual number of average declines on the SP500 from 1928 to 2023 per percentage pullback...

The only real concern we then have is protecting our portfolios against the the big downturns and market crashes like the dotcom crash in 2000 and the Great Financial Crisis (GFC) in 2008.

Most Years See Positive Returns no Matter What Happens During the Year

It's also worth keeping in mind that most years of stock market returns are positive, and that includes when there are sizeable drawdowns during the year. The chart below shows the intra-year drawdowns in the UK FTSE between 1986 and 2025, so that includes the DotCom crash and the GFC of 2008. 27 our of the 39 years ended with positive returns. The same will be true if you are invested in the SP500 or a standard globally diversified stocks fund...

... and when there is a pullback (-10%), corrections (-20%), or crash (-30%+), the outlook for long term gains are still good...

When Bear turns to Bull ...

Our "Financial Crash Tracking" page is an attempt to detect the signs of an upcoming downturn or secular (longer term) pullback in markets. But it's not just about assessing the risk of a secular bear market. We are looking for when a potential bottom and upturn has been established in a bear market. This helps to decide when the re-enter a market and also other portfolio allocation decisions such as bond allocation for a long term investment portfolio. For example in the GFC 2008, bonds, and in particular, government bonds were the only asset class that did not crash.

I send out a summary each month in the BBI newsletter for subscribers. Subscribe on the homepage or on the bottom of this page if you are interested.

So, in assessing the risk of a secular downturn in the stock market we are using a combination of Fundamental Analysis and Technical Analysis to gauge the degree to which we are seeing a 'secular' bear (or bull) market materialise: -

1. Technical Analysis (TA): Charts which points to a secular change of trend from bull to bear, boom to bust (and then vice versa... bear to bull)

2. Fundamental Analysis (FA): A systemic level crash narrative and major fundamental indicators that precede or illuminate a secular crash/bear is underway.

Below is a run through of the main charts and indicators we monitor here at Boom Bust Invest

Technical Analysis For Stock Market Boom and Busts

There are a number of charts over the long, medium, and short term that will inform us if a meaningful change of trend is happening and this is the first level of analysis that we need to see to know if something is starting to head in the wrong direction in a meaningful way. 

• The 'secular' big picture: Monthly and/or quarterly charts.

• The big/medium picture: Weekly charts.

• The little picture: Daily charts.

In these charts I use the same moving averages and momentum indicators to tell me where price action is likely heading. In a sense the same concept that can be used in short term 'trading' (as opposed to our use case of long term investing) is used whereby we use the lower time frames (weekly and daily) as trend change signallers and confirmation to initiate mitigation at the high time frames... the big picture.

The daily chart is our initial warning sign which alerts us to the handful of 2% to 5% pullbacks and these often sort themselves out with buyers stepping in and then a resumption of the secular trend, so we ignore for the most part, but nonetheless, every crash will begin with one of these smaller pullbacks so we still want to know about it.

The weekly chart is our sweet spot that we can choose to begin mitigation of the larger pullbacks that lead to corrections and crashes. 

Fundamental Analysis For For Stock Market Boom and Busts

Is There a Systemic Level Narrative or Trigger For a Crash or Secular Decline in Global Stock Markets?

I have discussed elsewhere in this blog about the fallout from the GFC 2008 and how the consequent globally co-ordinated central banking ZIRP (Zero Interest Rate Policy) has blown up what has been called the  "Everything bubble" in all (or most) asset classes. This theory may end up being overblown itself in favour of what may just be 'strong stock market returns' since the GFC 2008.

However, there is no doubt that unprecedented central bank and government intervention has precipitated the miraculous stock market recovery post GFC and if the 'everything bubble' is real then it is likely that the market is setup for a fall at some stage in the not too distant future. Many analysts believe we are 'late cycle' in the current economic cycle and that the post GFC market exuberance is symptomatic of this late cycle market behaviour.

The graph below shows the trigger/narrative for each of the last 3 big artificially created market crashes. The Covid crash was a very unusual natural disaster so we have put that to one side. The 3 artificial triggers leading to the last 3 major recessions were talked about long before the recession actually occurred.

The current trigger narrative is kind of an amalgamation of all 3 previous triggers. We have a potentially delusional AI tech bubble, we have yet another housing bubble that has been blown up by the aforementioned ZIRP, and we have the potential for major escalation of two global wars.

So, as far as the trigger narrative goes for the bursting of this current bubble, we must simply observe which of these start to gain momentum. We could have 2 or more gaining momentum at the same time or god forbid, all 3. There is also another trigger/source for global contagion from China (see below).

A big part of what we do here at BBI is to track all of these fundamental risk narratives along with the Fundamental Indexes and Indicators below and Technical Indicators (see above) to provide the best assessment of the risk to, and likely direction of global stock funds...

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Global Contagion Risk

There is an important side note to the first Cofactor (although its actually a lot more than a side note), and that is... knowing where we are in overall stock/economic cycle. The real situation we are attempting to mitigate here is the 1929/2008 (Great Depression/Great Financial Crisis) scenario. Along the way there is always volatility. A 1987 style rapid crash with a few weeks of breath-catching, and then a slow but steady resumption to the default upwards market drift isn't a big deal, in the grand scheme of things, even though it may seem like it at the time.

The Great Financial Crisis of 2008 started in the US because of the contagion risk in mortgage backed securities sold into the global markets. One of the downsides of a more connected world is contagion risk. Where is the contagion risk today?

• Real Estate (Commercial AND Residential)

The commercial real estate market globally is undergoing severe headwinds due to the post pandemic 'work from home' revolution. The Federal Reserve Bank in the US is paying down this risk but I suspect it is, or will be, worse than they are making it out to be. They are being hit  with a double whammy of lack of demand (work from home) and high interest rates.

High interest rates are also hitting the residential housing market. We are  only really just beginning this 'higher for longer' period of interest rates so it is logical to expect mortgage delinquencies to rise in the coming years. Since the GFC 2008 we have  had 15 years of zero interest rates which has inflated property prices. In 2022/23 we then saw the fastest rate hike in history to control inflation. Again, logically, assets priced at the historically low interest rates should re-price to the higher rates.

The above can be applied to most developed Western economies, but also to the biggest housing market of them all... China. The risk here is a potential Western and Eastern real estate contagion/sell off triggered by post pandemic inflation and interest rate changes.

• Is China the New Global Contagion Risk? (Financial or War)

The economic problems in China have been well documented over the past few years. Over the past year though they have been intensifying and appear to be building up to something bigger. Some analysts are pointing to a Chinese 'Lehman' moment where a systemically big enough company/bank/market (or combination of) will collapse and spark contagion in global markets and a sell off in the global equity funds that we are all invested in.

However, markets can remain irrational for long periods of time and herein lies the seeds of the possible opposite scenario to a global sell-off. China will probably not allow a total collapse of their economy and are likely to come to the rescue of their beleaguered property and local governments with almighty QE (money printing) programs. This is just kicking the can down the road, and China knows that, but it is still more likely to happen than not. 

If China does decide to kick the can down the road, the future debt problem will be worse, but it would provide a significant boost to global liquidity in the near term. That could provide the fuel for an additional leg higher for global stock markets. It could further inflate the frothy valuations currently evident among the mega-caps on Wall Street. 

So we are keeping a close eye on Chinese QE and will let you know if this starts to materialise.

There is also a chance the China actually chooses to go through the pain now and allow the collapse of the financially dysfunctional institutions in its midst and in so doing, steal a march on the US which will at some stage have to go through the same kind of pain. 

Finally, there is the ongoing risk of China invading Taiwan which would likely provoke a military reaction from the US.

• ... or Japan?

 Japan has the second biggest bond market in the world, and is the 3rd largest economy in the world. The country has a very high debt to GDP ratio of about 240% in 2024 but was as high as 260% in 2020. With poor demographics, Japan could start running into trouble in the future. With foreign holdings of bonds and other assets in the order of $3 trillion (the highest of any nation in the world) the risk of contagion would be high.

So, we are not there yet but if we start to see Japans economy and government debt  spiral out of control then we would need to monitor that situation. 

• ... or an escalation of the Russia/Ukraine or Middle East wars?

The most damaging, but currently unlikely, risk to financial markets would be some kind of tactical nuclear escalation or an attack on a NATO country. Either of these happen... markets would crash. US and Israel may have to deal with the threat of an Iranian nuclear capability before they achieve this capability which increases the chance of an escalation in the middle east. These are very volatile situations and so we monitor for signs of escalation.

FA Cofactor: Where are we in Stocks and Economic Cycle

There is an important side note to the first Cofactor (although its actually a lot more than a side note), and that is... knowing where we are in overall stock/economic cycle. The real situation we are attempting to mitigate here is the 1929/2008 (Great Depression/Great Financial Crisis) scenario. Along the way there is always volatility. A 1987 style rapid crash with a few weeks of breath-catching, and then a slow but steady resumption to the default upwards market drift isn't a big deal, in the grand scheme of things, even though it may seem like it at the time.

'Buy & Hold' investors (i.e. 99% of investors) can get away with the 1987's without lifting a finger, but another 1929, 2000 (Dot Com), or 2008 (GFC)  is a different matter. All we are interested in is the emergence of the next 1929, 2000, or 2008.

These larger crashes happen in boom-bust cycles. This cyclical pattern is shown below in it's recognised stages. So what we are concerned with here is identifying when we are in the "stage 3 topping pattern" seen before a larger bear market downturn (stage 4)...

The stock market cycle is 6 months to a year ahead of the economic cycle. So by the time the economic cycle peaks, the stock market will be 6 months to a year into a downturn. This isn't something to track too closely, it's just something to keep an eye on to gauge the signs that we are nearing a top/peak in markets... 

So for example, when you see the Energy and Precious Metals sectors doing better than other sector, it's a big clue that we are at or approaching the topping phase of the stock market (as shown above).

As we speak in 2024 we are seeing Energy and Precious Metals among the leading trending sectors. Healthcare has also been in favour. Another tick in the box. We have seen (or are still going through) the 'Greed', 'Delusional New Paradigm' stages.. "AI AI AI". 

In order of importance (or usefulness) for building a predictive and/or current picture for financial markets, below is a checklist of the main charts and indicators we use at BBI...

Fundamental Analysis: The Main Recession Risk & Unemployemnt & Financial Distress Indicators

Earnings

Risk-On vs Risk-Off: STOCK Market Breadth/VOLATILITY/FUND FLOWS

Finally... The Bad Times Never Last Forever

To end on a positive note, all of the market crashes since the Great Depression of 1929, in the biggest stock market in the world, the US 500 are listed below with their associated recession lengths. At some point within at most 3 years, they reach a bottom and investors start piling in again at bargain prices. So in a sense, stock market crashes are self correcting. The point is to try to maximise returns at the point of maximum pessimism as Warren Buffet would say, buy buying near the bottom for the longer term. That is when market crashes can become a very lucrative opportunity...