Four Years Later, Is Another Market Crash Looming?

October 10, 2008 concluded the worst week in the history of the Dow Jones Industrial Average. Four years later, is a similar market crash looming?

It’s not an unreasonable question.

Global financial headwinds remain. European sovereign debt has only worsened. Greece, Ireland and Portugal have required bailouts in the last two years. Italy and Spain have been teetering on the brink of requesting their own. 

Domestically, growth is slow. Unemployment is higher than it was four years ago. Our own national debt continues to climb, exceeding $16 trillion at last check. Now there’s this thing called a “fiscal cliff” – which, if imposed, could send investors into an all-out panic.

That’s the bad news. The good news is that the U.S. economy – while slow moving – is nonetheless growing. Our gross domestic product has grown each of the last 13 quarters. In the fourth quarter of 2008, U.S. GDP dipped to -8.9% – a 50-year low.  

Banks have stabilized somewhat, distributing less bad loans than they did during the subprime mortgage lending crisis. The housing market is finally showing signs of a recovery. And many stocks are flourishing, with all three major U.S. indices reaching four-year highs over the summer.

But have stocks risen too high? Sure, we’re better off now than we were four years ago. But it’s not as if the data is positive enough to rationalize the kinds of gains we’ve seen this year.

All three indices are up more than 9% in 2012. The benchmark S&P 500 has gained close to 14%. The Dow has returned 9.5%. And the Nasdaq has climbed a whopping 17% year-to-date, and is hovering around its highest level since 2000.

Stocks weren’t nearly this overbought when the market crashed in the fall of 2008.

Let’s compare each index before it crashed in September/October 2008 to where it is now:

                                Fall 2008                                           Currently

Dow                       10,325.38                                            13,582.16

Nasdaq                    2,273.90                                            3,112.42

S&P 500                  1,255                                                  1,455

Beginning in mid-September of 2008, all three indices plummeted to levels not seen since the late 1990s. In a matter of five and a half months, the S&P declined 45.5%, the Nasdaq collapsed 43% and the Dow dropped 42% – highlighted by the record 18% drop-off the week of October 10.

It was the worst stock market crash since the Great Depression.

Is a similar market crash possible just four years later? If the fiscal cliff becomes a reality, will it push America into a double-dip recession like some analysts are predicting? Will the debt issues plaguing the euro zone eventually make their way to the U.S.?

No one truly knows the answer to these questions. However, the mere presence of all these unknowns is enough to create some serious doubt in investors’ minds.

As I wrote last week, we won’t know the fate of President Obama’s Budget Control Act – the alleged fiscal cliff-creating law scheduled to take effect at midnight on December 31 – until after the election. Nor do we know what’s going to happen next in Europe – and what impact its deep-rooted sovereign debt problems may have on U.S. markets down the road.

What we do know is this: Stocks are overbought, unemployment is still high despite dipping below 8% for the first time in 44 months, and economic growth is so slow that the Federal Reserve just enacted a third round of quantitative easing.

That may not add up to another market crash. But it is reason to take caution in your investing – at least until after the election.