Home prices are rising again, the stock market is at all-time highs, and unemployment is relatively low. For many of us, life is really good especially when we compare it to the 2008-2009 recession periods. I remember on the ride home from work WTOP’s Business News correspondent Jeff Clabaugh would always have depressing news to report and would deliver it so casually.
It’s because every day it became a routine for the stock market dropping 500 points and then the next day coming back up 300 points. It was truly like a roller coaster. And then jobs data (company A lay’s off 10,000, company B lays off 20,000) and housing prices continuing to fall. But we have prevailed and have benefitted from a nice ride as the S&P has shot up over 350% from Spring 2009 to Fall 2017:
When Will Something Bad Happen?
For the moment, unemployment is great sitting at a little above 4%. It has continued to drop from its peak at around 10% back in 2010 in the aftermath of the recession.
Why Would Something Bad Happen?
There are indicators out there. Market Watch has identified seven signs including the CBOE Volatility Index (VIX), Dow Transportation Index which is not in alignment with the actual Dow Jones Industrial Average and campaign promises from President Trump that have not yet been met. These include tax cuts and spending on construction which initially resulted in market gains. Market Watch believes that valuations are super-high. As a result, we should not be investing in passively managed funds since they track the index which itself is so expensive.
The article goes on to suggest that it may be better to just hold onto cash, which I totally understand and especially if your investment time horizon is shorter. We’ve enjoyed a good rally, but at the same time, it can be argued that stocks are over-priced. I looked up 10 stocks (5 large cap and 5 small cap) below with their P/E ratios as compared to the S&P 500 P/E ratio which is 24.61 at the time of this writing:
|Stock||P/E Ratio||> 24.61 S&P 500 P/E Ratio|
Seven out of 10 stocks above have P/E ratios lower than the S&P 500. According to this, the argument could be made that it’s better to find undervalued stocks individually rather than investing in an index that tracks the S&P 500. Or it may be better to invest in a small cap ETF!
Even Warren Buffett may think the market is flying way to high. His Berkshire Hathaway has an all-time high of $100 billion in cash on hand. Buffett loves to invest, but only at bargain prices. There is solid argument in place that we may not be experiencing those bargain prices at the moment. His comparison of the value of equities versus the size of the economy shows that the former is 135% of U.S. GDP. This means that stock valuations are too high.
How Can We Prepare Now?
Selling or rebalancing would not be a bad option, even for long-term investors. In terms of selling, according to 10 Golden Money Tips by Financial Advisor Jacob Nayman, he says in tip number 7 that even if you’re a long-term investor, it’s not recommended to hold stocks no matter what happens in the market. His example talks about a case where severe and continued economic concerns are present. But at the same time, he does recommend that long-term investors stay invested in the market for at least two years if the market is not on a continuous path downward. Rebalancing allows you to limit the exposure in certain industries that may be suffering.
For example, if no one is upgrading their cell phone and companies such as Apple and Samsung show signs of slow down, you can sell a part of your position in that fund before the loss becomes tremendous, and maybe buy a total market ETF instead. This way you reduce your exposure to the technology and communications sector, while still being invested in the overall market.
Rebalancing can mean moving some money from stocks to bonds. If you’re retired or almost at retirement, this would make more sense so as to preserve your nest egg. I’ve read that this can be done in small increments. For example, once a month you may decide to move $10,000-$20,000 from stocks into bonds so that you’re averaging the price out.
A correction/downturn can typically last about seven years. Assuming you’re almost at retirement and your home is paid off, your average annual household expenses may be about $50,000. That would mean you’d need $350,000 to last for up to 7 years – during the downturn of the market. And it would mean that you’d have to transfer over $20,000 from stocks to bonds each month for almost 18 months to accumulate that amount in more safe cash. But for most retirees, their investment portfolio is fairly conservative anyway.
So readers, do you think a market correction is near (less than 6 months away) or far (a year or more away)? Are you preparing for a correction; if so how? Are there any indicators you believe that are critical for a correction to occur which are or are not yet present in the market/economy?
I use Personal Capital because (1) it’s free, (2) it tracks all of my accounts and overall net worth, (3) my account balances automatically update, (4) it shows how my investments are diversified and allocated in various sectors, and (5) can use built-in tools like “Investment Checkup” to get….wait for it…free personalized advice!