Stock Market Crashes are often sudden and dramatic with no warning. They can last for a short period of less than 1 month or can extend for years.
The S&P500 has demonstrated in over 100 years that US Stock Market crashes always recover eventually.
The issue with Stock Market Crashes is:
- How severe is the fall
- How long until recover
Classification of Market Crashes
At Ultima Investment Services, we classify market downturns into two distinct categories based on historical corporate earnings data dating back to 1997:
News Event Crashes
Falls under -8%, full recovery within 3 months. Caused by geopolitical panic or energy shocks without fundamental earnings damage.
Bear Crashes
Falls around -10%, recovery within 6 months. Triggered by early business earnings drops and rising interest rate pressures.
Big Bear Crashes
Falls of -20% or more, recovery in 12 months or more. Driven by deep, sustained earnings collapse across multiple quarters.
For traders and fund managers, a major issue is how long to rebound or recover after a fall.
News Event Crashes recover very quickly, in less than 3 months, as there is no fundamental reason for a sustained crash.
Big Bear Crashes can last for over 12 months (some, such as in 2000/01, can last for 36 months).
What Are the Features of Each Crash Type and Can Any Be Predicted?
1News Event Crashes
The primary cause is a major negative news event such as:
- War(s)
- Oil or other energy supply restrictions (export tariffs, embargoes, etc.)
- Adverse political policies that have a negative impact on business profits
- Trade import tariffs and other import/export restrictions
With these types of events, there is usually a sudden huge drop in the S&P500.
Trading entities such as the e-mini ES futures and others always hold a large number of algo stop loss orders that are executable 23 hours a day and for almost 7 days a week.
When stop loss levels are hit, orders are filled at almost any price, which escalates the price fall into a flood.
A common feature of news event crashes is that investors quickly review whether the event will have a major impact on business profits or not. With News Event Crashes, forecast business Earnings reported just after the crash starts by S&P500 companies do not indicate a significant fall in Earnings.
These types of crashes do not usually result in a major Bear down period over an extended period.
The S&P500 prices rebound quite quickly, usually within three months.
2Bear and Big Bear Crashes
The primary cause is a business earnings crash.
Business profits fall for most companies when:
- Interest rates rise more than 2 to 3% as consumer spending is decimated (especially discretionary spending).
- Major political policies that reduce business profits such as:
- Escalation in employee wages
- Additional employment costs
- Additional compliance costs
- Anti business development approval processes
- New or increased taxes on consumers
With this type of crash, the S&P500 may fall initially a large amount, but more likely there will be a series of falls with false rebounds until business Earnings recover.
A major fall in Earnings over one Quarter is likely to lead to a Bear Crash. Huge falls in Earnings or accumulated falls over more than one Quarter is likely to result in a Big Bear Crash.
Companies issue EPS Estimates which are the best indication of business profits and how long the crash will last. Basically when Earnings recover, share prices will recover.
A Bear Crash continues for around 6 months. If it extends for more than 12 months it can be regarded as a Big Bear crash.
Can Crashes Be Predicted
Firstly, what does "Predictable" mean with regard to trading the stock market. Many technical indicators use the term predictable or forecast or projected turning points or divergence signals to describe the occurrence of a technical signal but for a crash that occurs on the same day.
This is simultaneous or coincident — it is not predictive as a trader can not take action before the crash occurs. Most are actually lagging by 1 day or several days.
A prediction is only of value to a trader or Fund Manager if the indicator or signal is provided at least 1 day in advance of the crash. Ideally a week or even one month's warning would be preferred.
News Event Crashes are not predictable
News event crashes are unpredictable. These types of crashes are usually short lived not leading to a Bear crash.
As recovery is usually in less than three months, most traders and Fund Managers can just Buy and Hold through a News Event Crash.
Bear and Big Bear Crashes are predictable
Business Earnings crashes are definitely predictable! This means Bear and Big Bear Crashes.
S&P500 companies issue EPS Estimates every Quarter for the next 4 Quarters. They are also expected to be revised as circumstances change.
Estimates vary and some companies are more accurate than others but across the 500 companies, the average EPS is a good indicator of future S&P500 trend.
Interpretation of EPS Estimates data is difficult. How do traders and investors react to different types of EPS Estimates releases and revisions.
UIS has analysed 65 years of trader and investor behaviour after EPS Estimates are released. UIS has created a method that assesses the probability of a Bear or Big Bear crash in the next 12 months.
UIS Risk Ratings are provided to give at least one month's advance warning of a Bear or Big Bear Crash.
Since 1997, the UIS Risk Ratings have correctly identified 100% of the Bear and Big Bear crashes and in advance of the occurrence.
