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The S&P 500 and Nasdaq both broke record highs last week (Jan. 6) as the Dow nears a record 20,000 points. But with stocks soaring, the possibility of a stock market crash coming is on the rise, too…
Normally, rising stock prices would be great for investors. But if soaring stocks are creating a stock market bubble, then investors need to be prepared for a pullback.
We'll show you exactly how to keep your money safe in case of a stock market crash. Before we do that, we want to show you why the stock market is too high. And what triggers could cause a stock market crash…
Why Is a Stock Market Crash Coming?
Overinflated stock prices could be a sign of a bubble. And stock market bubbles have led to major stock market crashes in the past…
The stock market crash of 1929 was brought on by a stock market bubble.
Simply put, investors bought up stocks because they thought the markets would only go up. This led to investors taking risks they couldn't afford to.
Amateur investors borrowed $8.5 billion (in today's dollars) to buy stocks with. As long as stocks kept going up, everyone was making money. And as long as more people were buying stocks, prices continued to soar.
But when prices began to fall, these investors were forced to sell, sending prices in a downward spiral.
The collapse of the stock market led to an 86% drop in the value of the Dow between September 1929 and June 1932.
Editor's Note: Check Out Our Essential Guide to Buying Gold and Silver
Another speculative bubble would lead to a stock market crash in 2008.
Housing prices were steadily rising in the decade leading up to the crash. Home prices almost doubled between 1996 and 2006.
And just like in the 1920s, soaring prices led investors to believe they would continue to rise. Banks were encouraging home-buying with tantalizing loans. Wall Street began packaging mortgages, even the riskiest subprime mortgages, into tradeable investments. As long as prices continued to rise, everyone was making money.
But home prices would eventually fall. As home prices fell, those who couldn't afford their mortgages were forced to sell or face foreclosure. Prices plummeted. Housing prices fell 30% between 2007 and 2009.
The collapse of the housing market led to a stock market crash and financial crisis. The market crash was so severe the Dow lost nearly 7% of its value on Sept. 29, 2008, the largest single-day fall in Dow history.
Now, we are seeing similar signs of speculation fueling stocks to record highs.
Stocks are soaring, but it isn't economic growth driving prices. Instead, cheap money from low interest rates has flooded into the stock market.
The Fed cut interest rates from over 5% in 2007 down to 0.25% by 2008. Since then, the Fed has only raised interest rates twice, and they continue to remain under 1%.
Low interest rates were meant to make borrowing money cheap so businesses would be more willing to spend money to grow, boosting the economy.
But businesses have taken advantage of cheap borrowing to buy stock. Corporations have borrowed $1.9 trillion since interest rates were slashed in 2008. During the same time, corporations bought back over $2 trillion of their own stock.
This drives up share prices and rewards investors. But it also makes the stock market grow faster than it normally would.
With stock prices artificially inflated through low interest rates, a market correction could be severe.
And it's created the possibility of a stock market crash in 2017…
What Could Cause a Stock Market Crash
Higher interest rates is one of the biggest risk factors of a stock market crash in 2017.
At the December FOMC meeting, the Fed announced it would raise interest rates. This was only the second time the Fed raised rates since slashing them below 1% in 2008.
The Fed raised rates at the December 2015 FOMC meeting. And the major stock indexes fell more than 10% over the following month. Check out how the market reacted to the 2015 rate hike in the chart below…
Even after the most recent rate hike in December 2016, interest rates remain under 1%.
That won't last much longer.
At the same FOMC meeting, Fed officials predicted they would raise interest rates three times in 2017 and push interest rates above 1% for the first time since 2008.
That means borrowing will become more expensive so companies won't be as willing to buy back shares of their own stock.
And with less money going into the stock market, stock prices will fall. As with other stock market crashes in the past, as prices fall, investors sell, causing prices to spiral even lower.
With higher interest rates on the horizon, investors need to be prepared for a stock market crash coming next. That's why we've made our guide on how to protect your money during a market collapse. Here's how to do it…