Picture used for illustrative purposes. There's been much debate surrounding whether world stock markets are in a false state of euphoria, inching towards an inevitable crash. Image Credit: AFP

Dubai: While most analysts are optimistic of 2021 to be a year of bigger gains, after investors raked in much this year despite a pandemic-related crash, a debate still stands on if stocks will collapse this year.

The S&P 500 index in the US, which is mirrored by stock markets worldwide and is seen as a gauge for market-wide investor sentiment, is up nearly 15 per cent for the year. By some measures of stock valuation, the market is nearing levels last seen in 2000, the year the dot-com bubble began to burst.

What is the dot-com bubble?
The dot-com bubble (also known as the dot-com boom, the tech bubble, and the internet bubble) was a stock market bubble caused by excessive speculation of internet-related companies in the late 1990s, a period of massive growth in the use and adoption of the internet.

The bubble did eventually burst, leading to the stock market crash of 2000. The years 1992-2000 were favourable for the stock market and the dot-com boom was in full effect.

Euphoria readings are highest in two decades

The reading of the widely cited Citibank Panic/Euphoria Model—which factors in a number of metrics from options trading to debt—have reached the highest level since 2000.

What this euphoric readings indicate is the likelihood of losing money in the coming 12 months, and some market experts warn that the data shows the chances of a crash are high when studying historical patterns. Investors saw such levels back in early September as well, right before a selloff in stocks.

Additionally there is another reasoning that supports this view. The volume for call options are at an all-time record. (A call option is a contract that gives you the right to buy a stock in the future at an agreed price. It is a product that’s used as a leveraged (borrowed money) way to profit from rising stocks.)

Renowned veteran investor, who accurately predicted the 2008 and dot-com crashes, Peter Boockvar, sounded the alarm that the investors sentiment behind the record volume of call options, is a red flag.

Some view a market crash by 2022-end, 2023

However, most market trend watchers do not hold this view. With global stocks largely viewed having some more momentum to rise, despite being over-priced currently, the stock market is largely expected to bottom late in 2022 or early 2023- which is equally bad for those currently invested in the long run.

To know for certain if doubts on whether the timeline could be pushed up merits any attention, depends on any potential catalytic triggers like any uncertainty relating to vaccine-related progress, or developments surrounding the new strain of coronavirus spotted in a few countries.

Analysts, however, agree on one fact. If markets do crash, it will be the lowest stock market of this lifetime.

When COVID-19 hit, the world witnessed what is referred to as a short-term depression. It took GDP down 9.5 per cent in the second quarter, equivalent of 32.9 per cent annual rate of decline. However, while that’s a depression, it’s not a recession.

What is the difference between a recession and a depression?
A recession is a widespread economic decline that lasts for several months. A depression is a more severe downturn that lasts for years. There have been 33 recessions since 1854. There's been only one depression, the Great Depression.

How quick will economies, sectors recover?

Analysts worldwide have seen a V-shaped (quick and brief) recovery for 80 per cent of the non-travel, non-entertainment sectors, which are the sectors that were not heavily affected by COVID-19. The current view that many are basing their assumptions on is that now all other sectors will recover too.

This is a view that is taken on by many analysts, however, this also an assumption many disagree on. The conclusion is that not all sectors will recover just as quick, and for instance, aviation and hospitality companies worldwide will take a lot longer to rebound, with recovery prolonging at least by 2-3 years.

As long as this market goes up and quickly recovers, investors don’t see much risk of markets crashing. That’s why many are buying call options on 10 times leverage as the existing mentality is to buy into this market and be over-reliant on global central banks to come to the rescue and drive share prices back up.

What are the well-experienced investors doing?

An interesting trend was that the ‘smart money’ has been selling into this rally just like they did in the 2007-2008 crisis. Those who foresee this stock market crash happening have been selling into this rally over the last five months, multiple data indicates.

What is the ‘smart money’?
Smart money is cash invested or wagered by those considered experienced or well informed. As such, the smart money is considered to have a much better chance of success when the trading patterns of institutional investors (major investment firms) diverge from retail investors (individual investors).

It’s the small traders who are loading up on call options, analysts reveal. When there was a kind of V-shaped recovery after the pandemic-induced crash in March and the central banks stepped in, they started piling a lot of money into call options, which makes a crash all the more inevitable.

What if an investor doesn’t want to sell stocks now?

If you want to stay in stocks, experts recommend that you hedge your money and buy a ‘put option’ to hedge.

What is a ‘put option’?
A put option is a contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a pre-determined price within a specified time frame. This pre-determined price that buyer of the put option can sell at is called the strike price.

Analysts say you can probably do that for 3 per cent to 4 per cent of the investment cost, which is worth doing if you want to hold onto stocks late in a market bubble, and is what is loosely termed as “cheap insurance”.

The reasoning behind this is that once you have another serious market crash, you won’t get that cheap insurance again, in line with the skeptical view that this is the last new market high before another strong correction (decline) in stocks.