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With stocks near all-time highs, traders are concerned the Fed could cause a stock market crash this week when it raises interest rates.
The Dow has closed at a record high over the last six days. It also hit its all-time high of 19,951.55 on Tuesday (Dec. 14). The S&P 500 and Nasdaq are also within striking distance of their all-time records. These jaw-dropping numbers are why some investors are wondering if we are now in a stock market bubble.
Now, investors are afraid a bubble could pop when the Fed raises rates this week. According to the CME FedWatch Tool, there is a 95.4% probability the FOMC will raise rates.
That's why we're going to show you how to protect your money during a stock market crash. But first, this is why the Fed's interest rate decision could have a major impact on the markets…
Could the Fed Cause a Stock Market Crash This Week?
Interest rates have been at a historically low level for nearly eight years. Interest rates haven't risen above 1% since the Fed slashed rates after the 2008 financial crisis.
Low interest rates have helped fuel the record-breaking stock market. But these record highs aren't all good. An artificially high stock market is ripe for a correction.
Just look at what happened when the Fed raised rates last year. The chart below shows the market absorbed the news, but then fell for a month straight. With markets at even higher levels today, it's possible the Fed's impact could be even greater this time.
On top of this, interest rates have helped fuel these record highs in the first place. These are the two big reasons low interest rates have helped artificially inflate the stock market.
First, when rates are this low, investors can't make money in bonds. Instead, investors are forced into the stock market as the only place where they can make a decent return.
That means money that normally wouldn't be in the stock market has flooded in, driving up prices.
Second, low interest rates mean borrowing money is cheap and easy. This has allowed corporations to borrow money cheaply. Except, they have used the money to buy shares of their own stock. This means stock prices are driven up as more stocks are being bought with this easy money.
Since the Fed cut rates in 2008, corporate debt has increased to $1.91 trillion. During the same time, corporations have repurchased their own shares to the tune of $2.2 trillion.
This sort of artificial inflation could be why we are seeing such record-breaking highs in the stock market. On Dec. 1, all five major stock indexes in the United States hit record highs. The last time that was seen was 1998. The Dow just broke its all-time high yesterday (Tuesday, Dec 13) as it nears the 20,000 level for the first time ever.
These overvalued stock prices are why many traders are concerned the Fed could cause a stock market crash this week. And overvalued stock markets have led to financial crashes in the past…
What Causes a Stock Market Crash?
Stock market crashes are often preceded by a bubble. A stock market bubble is a period of unbridled enthusiasm for investments that is not sustainable on the fundamentals.
In 2008, a housing bubble led to a stock market crash.
Home prices had been steadily rising for a decade. Buyers flocked to the market to cash in on climbing prices. Banks were even offering subprime loans to unqualified buyers because as long as prices rose, the loans could be refinanced and paid back. Everyone was benefiting.
But home prices eventually went down.
Many home owners could no longer make their payments when they couldn't refinance. Houses were foreclosed on. Investors across the board lost money in housing.
But as the housing bubble collapsed, it became apparent how much housing was connected to the stock market. As the housing market fell, so too did the stock market.
During the stock market crash of 2008, almost $2 trillion in retirement funds vanished.
And 2008 was mild compared to the 1929 stock market crash.
The stock market crash of 1929 was preceded by a different kind of stock market bubble. As the Roaring '20s raged on, many investors believed the market could only go up.
Average investors borrowed almost $125 billion, in today's dollars, to buy stocks. The added money drove stock prices higher. As long as stock prices kept rising, these investors were making money. And as long as prices were going up, more people were buying in.
The artificially high market didn't last. When the market began to fall, thousands of investors sold their shares, hoping to get some value out of their investments. As people sold stocks, prices fell drastically. The panic was so severe, some sellers couldn't find a buyer at any price.
Overall, the Dow Jones Industrial Average lost a whopping 86% between the 1929 crash and the recovery in 1932.
Today, we are seeing signs of an overinflated stock market thanks to low interest rates from the Fed.
That's why some investors are concerned a rate hike from the Fed could lead to a market correction or a 2017 stock market crash. And with the Fed set to raise interest rates this week, there's no better time to protect your money from a possible stock market crash…