You almost certainly are exaggerating the likelihood that the stock market will, in coming months, suffer a crash as bad as that of 1987. Contrarians are smiling.
It’s entirely understandable that investors are worried about a crash, given the many analysts who are declaring the stock market to be forming a bubble. Keith McCullough, the CEO of Hedgeye Risk Management — who my colleague Jonathan Burton interviewed earlier this week — says that “there are a lot of similarities to 1987 now: the market’s quick start in January, people in love with stocks. That’s a catalyst for the stock market to crash.” In fact, though, the probability of a 1987-magnitude crash in the next several months is very tiny — just 0.33%. We know what the average investor believes the probability of a crash to be because of a survey that Yale University’s Robert Shiller began conducting several decades ago. He distills his results into one number: the proportion of respondents who think there is a less-than-10% probability of a 1987-magnitude crash in the subsequent six months. According to the latest survey, that number is 33.9%. That means 66.1% of investors believe that the risk is above 10%. And that’s what is plotted in the accompanying chart. Notice that there has been a distinct uptrend in this percentage in recent years. In 2015, its 24-month moving average stood at 64%, v …
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