Jump to main navigation Jump to main content. Last updated Tuesday, Feb. Popular metrics of market valuation — such as price to forward earnings, price to book value, price to cash flow and cyclically adjusted price to earnings CAPE — indicate the U. With so many indicators flashing red, what is the likelihood that the stock market may crash? Normally, it is difficult to determine whether a bubble exists until it is too late.

But even if we know we are in a bubble, it is difficult to foresee when it will burst. In light of this, a recent study on the topic of bubbles and crashes got my attention. But they also found that behavioural and certain other issues affecting the workings of the market are more significant than macroeconomic factors in explaining crashes. When cumulative returns are below this benchmark, you have a crash event.

In the 40 markets examined, there were crashes between and The average stock market decline was 25 per cent and average duration of the decline was 4. The impact of the crash was more severe in developing countries than developed countries. As noted above, the study found that behavioural factors are the most important determinants of both cumulative decline and duration of decline. The higher the irrational behaviour, the greater the probability of a crash. Liquidity and volatility, on the other hand, affect the severity of the crash and the speed of the decline — the greater the liquidity and the smaller the volatility the less severe the subsequent crash.

Moreover, the probability of the crash is negatively related to liquidity and positively related to volatility. So what are the proxies for the aforementioned indicators currently saying about the U.

The put-to-call indicator stands at 0. This is a sign of bullishness in the markets and may signify that the herd is becoming exuberant. Put prices are higher when market participants are more pessimistic about the direction of the market. The last two metrics taken together do indicate that the herd is becoming bullish regarding investing in the stock market, which, according to empirical evidence, increases the probability of a crash.

Second, a liquidity metric: The New York Stock Exchange annualized monthly volume to shares outstanding ratio, a proxy for liquidity, currently stands at 64 per cent, a level which is about the average for the past five years, and much lower than the preceding five years, over which it averaged about 95 per cent.

Third, a volatility metric: The Chicago Board Options Exchange volatility index VIX currently stands at around 11, the lowest level in years. According to the research cited above, this indicator points against the possibility of a stock market crash. So will there be a market crash?

The proxy indicators based on this academic study give kinetick forex data ambiguous signals about the possibility of a crash, despite the apparent overvaluation of the U. George Athanassakos is a professor of finance and holds the Determinants of stock market developing countries Graham Chair in Value Investing at the Richard Ivey School of Business, University of Western Ontario.

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