The Stock Market Crash | What You Must Know

The stock market is doomed and I’m selling everything. This is the type of comment I’m seeing all over social media right now. I get it. Everything’s taken a sudden dive from stocks to crypto, and I know a lot of you who watch my channel have just started investing. So, for you guys, this is understandably pretty worrying. So, today I thought it was important to address your concerns, explain what’s causing all this mayhem, and finally, give you my thoughts on how you can best navigate this storm. I’m prioritizing getting this article out quickly, so don’t expect the editing to be as slick as usual. It’s more important for you to hear the information so you can use it to your advantage.

The Four Main Reasons for the Plunge

So, why is the stock market plummeting? To put this into perspective, the S&P 500 dropped 3%, which was the biggest one-day drop in nearly 2 years. The Dow dropped 2.6%, while the Nasdaq slipped 3.4%. This sounds pretty alarming, and from my research, there are four main reasons for this. So, let’s go through them one by one so that we can see if we’re due another historic market crash similar to the 2008 financial crisis or just a little bump along the road.

Reason 1: Fear of Recession

Reason one, of course, is the fear of recession. Now, if the economy went into a recession, the stock market would most likely plummet. This isn’t always the case, as there have been a few exceptions to this, like in the 2020 recession, as the S&P 500 returned 16.3% for that year. However, that isn’t the norm. This makes sense, as during a recession, less money is being spent by people like you and me. Companies then start firing staff, leading to more people being unemployed, which causes people to spend even less. This results in companies also earning less, and most of the time stock prices being impacted. This is one vicious cycle, and I hope you can see why this would be a pretty bad situation to be in. So, if we aren’t in a recession yet, why is the stock market going down? Well, as the stock market is known as a leading indicator, whenever there is a hint of a recession happening, it reacts to that news pretty negatively. So, you’re probably thinking, “What was that hint?” Well, several data reports showed that the US had only added 114,000 jobs in July, below expectations of about 150,000, and that unemployment had risen to 4.3%. This is higher than any month since October 2021.

The Sahm Rule: A Recession Indicator?

Look, these numbers are far from a disaster. The unemployment rate is still relatively low, and the underperformance in hiring isn’t terrible. However, it has triggered something known as the Sahm Rule. This is a pretty cool little rule that activates when the average unemployment rate over 3 months goes up by at least 0.5% compared to its lowest point over the past year. The reason people take this seriously is because it’s accurately predicted every US recession since the Second World War. In response, Goldman Sachs raised its odds of a recession occurring in the next year from 15 to 25%. Interestingly, the woman who came up with the rule, Claudia Sahm, doesn’t think the rule is going to be right this time. And to put your mind at ease, there have been other rules like this before, such as the bond yield curves that turned out to be unreliable recently. One reason why it might be a false alarm is that this time around, unemployment isn’t rising because people are losing their jobs. Instead, it’s because more people are entering the workforce.

Consumer Spending and a Glimmer of Hope

However, as I mentioned before, unemployment rising is only one factor in the vicious cycle of a recession. The other important one is the amount of money everyday people are spending. Unfortunately, it looks like spending is slowing down, too. Now, it may sound odd, but a good way to gauge this is by checking how companies like McDonald’s and Walmart are doing. And both have recently said their customers are cutting back on spending. Another company to watch is Wayfair. I actually buy a lot of my furniture from them. I’m actually sitting on a Wayfair chair right now. They recently mentioned that customers are being very cautious, with spending down nearly 25% from 3 years ago. Now, this all sounds pretty worrying. However, when it comes to the Sahm Rule, this time around, I’m taking it with a pinch of salt. Even Goldman Sachs seem to agree. Although they’ve increased their projection on the risk of recession, they still think it’s pretty unlikely. There’s also a lot of time for the big dogs at the Federal Reserve to swoop in and protect the economy, which leads me nicely on to…

Reason 2: Interest Rates (And Why This Time Is Different)

Reason two is interest rates. Right, check out this graph. The last few times that the Fed cut interest rates from their peak, a recession followed closely behind. And guess what’s just happened? You got it. The US Federal Reserve hinted after its meeting at the end of July that interest rates would soon be cut. Now, this graph also looks pretty concerning. However, it really doesn’t show us the full picture. To understand why this time is different from those past examples on the graph, we need to look at why the Federal Reserve initially put interest rates up in 2022. The answer is simple: the pandemic hit. Money printers were on full blast, and supply chains were suffering, leading to high inflation levels. The only way to bring prices back under control was to increase interest rates. This was an unprecedented situation, which I don’t think we’ll see again in our lifetimes, certainly not in mine. When they did this, they set an inflation rate target to hit and said they would start cutting rates once they achieved it. This strategy worked, and inflation has come down pretty significantly from its peak of 9.1% in 2022, but it still remains slightly above the Fed’s target rate of 2%. So now, if we go back to the graph, all those past examples of the Fed cutting interest rates was because they were trying to stop a recession from happening. However, this time, it’s because they are so close to hitting their inflation rate target. So the Fed cutting interest rates should actually be seen as a positive move for investors because it helps boost the economy. When rates are lower, borrowing money becomes easier, which means more money flows around. This is the opposite of what happens during a recession. So, on the surface, lots of these factors look worrying. However, when you dig a bit deeper, it doesn’t seem as bad as it looks. So, what else has caused the markets to drop so much?

Reason 3: Tech Stocks and the AI Bubble

That brings me on to reason three: tech stocks. If you recently invested in any of the top tech companies, then you were definitely hit harder than most, especially the stocks in a group known as the “Magnificent Seven,” which include Apple, Amazon, Alphabet, Meta, Microsoft, Tesla, and Nvidia. Now, you might be thinking, “That’s fine, I don’t invest in individual tech stocks.” However, this also impacts the S&P 500 index fund investors, as these top seven tech stocks actually make up about 31% of the S&P 500, meaning that when tech stocks get hit hard, so does the entire index fund. So, I guess the obvious question is, why are tech stocks suffering? Well, recently, these stocks have been soaring due to the promise of revolutionary AI technology. I went to a conference last year in Texas, and all they seemed to be banging on about was all these different AI tools I should be using in my business. I honestly got a bit sick of hearing it over and over again. It does seem like the AI craze has caused a bubble to form, pushing some stock prices higher than they should have ever been. And I think that investors are realizing this, causing stock prices to fall to more reasonable levels. Don’t get me wrong, I do definitely see the value in AI. It’s not like the metaverse… enough said about that, I think. I just think the value of our current AI capabilities have been widely overvalued, and that investors are realizing this, causing stock prices to fall to more reasonable levels. I’m not alone with this thinking, as Warren Buffett’s Berkshire Hathaway slashed its stake in Apple by almost 15% in the second quarter. There also seems to be bad news followed by more bad news coming from the AI space. I mean, just recently, the first preview of Apple Intelligence failed to live up to the hype, and Nvidia’s highly anticipated Blackwell chips will be delayed due to design flaws. These chip delays will also impact companies like Meta and Microsoft, so everything is pretty interconnected. Look, all in all, I personally think investors got a little hyped about AI, and it became a bit of a buzzword. It reminds me of when I was investing during the .com bubble in the late 1990s. Just keep in mind that the stocks with the sharpest booms tend to fall the furthest.

Reason 4: The Japanese Yen

Reason four is the Japanese Yen. Now, imagine you discovered this really clever loophole. You borrow money from someone with virtually no interest and invest it wisely. Meanwhile, the currency’s value drops significantly. By the time you need to repay the loan, the money you owe is worth much less than when you borrowed it, but your investment has grown. So, you end up repaying the devalued currency while profiting from your investment’s growth. Now, that would be a pretty cool life hack, right? Well, it’s exactly what lots of traders were doing with the Japanese Yen, as it’s been falling in value for years now. It’s a little more complicated than that, but I’m not going to bore you with all the details. It’s a cool trick to make some easy money. But why am I telling you this? Well, everything changed when the Bank of Japan decided to raise its main interest rate from nearly zero. So, once again, countries messing with the interest rates. This small change caused the value of the Japanese Yen to increase, meaning that everyone using the loophole I just described were a little bit screwed, as they had to sell their assets to cover their losses. Some experts believe that this could be contributing to the current decline in the stock market. Since all this went down, the Bank ofJapan has eased up on the talk of raising interest rates again. This has made the Yen drop a bit, which has gone some way to help calm the worries that a stronger Yen could mess with the global stock market.

My Thoughts: How to Adjust Your Investing Strategy

So, as you can see, there are lots of reasons behind the recent stock market decline. Now that you have all the facts, let me give you my thoughts on all of this and how you can adjust your investing strategy. As always, I’m not a financial advisor, and none of this should be taken as financial advice. I’m just speaking from years of experience, actually investing and seeing situations like this happen time and time again.

Strategy 1: “Buy When There’s Blood in the Water”

Firstly, throughout my investing journey, one phrase has always served me well: “Buy when there’s blood in the water.” In other words, when the stock market is in decline and people are panic selling, pushing prices down to irrational levels, that’s the time to step in and invest. Another phrase that teaches the same thing is “buy the dip.” I know it should go without saying, but if you want to do this, then you need to make sure you have an emergency fund of at least 3 to 5 months of your living expenses. This is more crucial than ever, as the stock market is in a turbulent time, and you don’t want to be forced to sell your stocks at a loss, only to find out later that if you’d held on, then you’d have actually come out ahead. Look, nobody can predict if the stock market is going to go up or continue downwards. However, I’ve always come out on top eventually by dollar-cost averaging into a low-cost S&P 500 index fund as it declines. This essentially just means buying at regular intervals as the price drops. This could be every day or every week. For all the people that have been reading my articles, waiting for the perfect chance to jump in and start investing, if I was in your shoes, I’d start my journey now. Yes, you can’t guarantee returns, but at least you’re entering at a lower price point. If you’re looking for a good investing platform to use, then one of my favorites is Trading 212.

Strategy 2: Make Sure You’re Diversified

Secondly, make sure you’re diversified. This basically means spreading your money across different baskets of assets, like stocks, bonds, and even crypto. This is key to reducing investment risk and smoothing the ride through a crazy market. So, if one stock or industry has a bad day, your other investments may help offset those losses. If you’re an index fund investor like me, then you’ll be pretty diversified anyway. But bear in mind that the S&P 500 is top-heavy with tech companies. So, it might be worth investing in a total US stock market fund to get even more diversification.

Strategy 3: Keep Your Eye on the Long Game

Thirdly, keep your eye on the long game. It’s easy to be positive when your portfolio is growing, but when things start to go a bit south and your gains start disappearing, it can be really tempting to sell everything. I’ve been there, but holding on has always worked out for me. Trying to guess the best times to buy and sell stocks is really tough and often leads to missed charges, according to Charles Schwab. Remember, if you sell when the market is down, you’re making those losses permanent. For example, during the COVID market crash in February 2020, if you had $1,000 in an ETF tracking the S&P 500, it would have lost over 30% of its value. Selling then would have locked in those losses. But if you’d held on, you would have seen your investment bounce back by August, just 7 months. If you’re waiting to jump back into the market when things look better, you’ll probably end up paying more and missing out on the rebound gains.

Conclusion: Corrections Are Normal

So, all in all, remember the US economy still remains pretty strong, even after the losses. The S&P 500 index is still up more than 9% since January. Market corrections, or a drop of at least 10% from their highs, occur on average every 1.5 to 2 years. So, this isn’t crazy or out of the ordinary. I actually heard a pretty good quote the other day, and it went something like this: “When the stock market goes up, it takes the stairs, and when it goes down, it jumps out of the window.” And recently, we’ve jumped out of a window from a pretty high floor because we’ve been going up a lot of stairs. Now, I think that sums up our current situation perfectly.