May 17: The Potential for a New Stock Market Crash

by David Jenyns on May 17, 2007

There are many signs pointing to an impending long term bear market (a period of decline in the value of stocks). The first and most important indicator is the outrageous use of credit that has created a crisis in the United States. As housing prices skyrocket all over the country, homeowners have used home equity credit lines to take advantage of these inflated values. Consumers have been maxing credit cards and credit lines in order to buy seemingly frivolous items, such as large electronics and luxury vehicles. Living above your means seems to be a national epidemic. What many consumers arenít facing is the reality that this unnecessary spending is using borrowed money which must eventually be paid back.

The federal government isnít setting a very good example with their own debt at $7.2 trillion. This national debt is growing by $1.71 billion per day. Between the government, business and household debt the country has accumulated over $40 trillion in debts. This is up from $13 trillion in 1990.

The stock market will be affected by rising interest rates. As these interest rates rise, it will become more difficult for debtors to pay interest. Many people will either default or declare bankruptcy. When a large amount of people are unable to pay off their debts it affects the entire economy. The stock market is directly affected as both consumers and businesses slow their spending. Banks, in turn, become insolvent from people defaulting on their loans. The credit crisis that has been created in the country can reach a boiling point in many ways, and that point will drastically affect the stock and bond markets.

The housing market boom has been fueled by mortgage rates that are at all time lows. When these mortgage rates rise, as they are bound to do, the real estate market will become bearish. Prospective home owners will be reluctant to accept such high mortgage payments, and the inflated housing prices will begin to drop. In addition, housing prices have become so inflated that many families cannot afford to purchase a home.

The housing market has traditionally been a large portion of the foundation for the US economy. Approximately 25% of the economy is in the real estate sector. This makes sense when one realizes that houses are biggest investments most people make in their lifetime. Housing prices are imperative to the success of many major home improvement and home furnishing companies. Any industry related with building, designing or decorating a home can be negatively affected by a drop in the housing market. Most banks also supported by the home loan interest they receive.

There are several studies that indicate falls in the housing market are worth twice as much as falls in the stock market. If the housing market falls 20 percent it will have the effect of the stock market falling 40 percent. The effect on the overall economy of the nation will be felt on a major scale. Given the overvalued real estate market of today, it would not be impossible for a 20 percent crash to occur in the near future.

The Baby Boomers reaching retirement age will also have a potentially limiting effect on the stock market and US economy. Throughout the 1970s, 1980s, and 1990s, the Boomers created massive capital flows into the stock market because of their interest in investments. As this generation group begins to retire, most if not all of them will begin to cash out their stock investments. Social security will be virtually no help so their only option for retirement funds is to cash their stocks in and invest in bonds.

The problem is that the Baby Boomers are the largest and wealthiest population group. Generation X, who is in position to purchase the stocks the Boomers are seller, is a much smaller generation group. Additionally, their buying power cannot compete with that of the exiting Baby Boomers. The increased cost of living has also resulted in less money for the Xíers to spend on investments.

The crash may occur because of the continued outsourcing of jobs. As more people in the country lose their jobs to foreign workers, their inability to pay personal debts will cause them to go bankrupt. In turn, the housing prices will begin to drop as foreclosures become more frequent. Stock prices and trading will be effected negatively and the retiring Baby Boomers selling stocks will also drive prices down. The result is a long bear market.

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