- We discuss the potential for a stock market crash, (one may be around the corner)
- How to prepare and what to do with this information?
- Is there an ideal portfolio composition that can weather a crash? Are there specific ETF’s I can use to mitigate risk?
Economic CyclesThe economy seems to go through large scale cycles through the years. There will be many years of growth and then a period of slow down. We seem to be at the end of a massive growth period. This does not mean a crash is right around the corner, but returns could be lower for a while. Many folks have now lived through several of these crashes. I am now convinced that these were great investing opportunities, and time has shown the market always comes back. Given this information one may be scared of investing or “crashes” for that matter. BUT, one must take the above chart very seriously to keep everything in perspective. No matter how many times the stock market crashes, the next one feels just as unexpected and just as painful. How should you protect yourself from the next market crash? First, you must understand why crashes happen.
What is the Problem Now?The only thing we really know for sure is that another crash will happen eventually. No one can tell us when. But we may be able to guess at what might cause it.
Meme stock mania, easy money printing, over heating, crypto mania, climate change devastation, WWIII…There seem to be several risk factors brewing at the moment. First we are living in a strange “meme stock” era where valuations of companies are becoming completely divorced of fundamentals. GameStop and AMC can lose money hand over fist and see their stock prices skyrocket. There are many other examples of this. Where is it all headed, we don’t fully know, but in the long run I am not sure how a company can maintain a high stock price and make small amounts of money. Some companies can do this as they build out a new technology (i.e Amazon), but not many can. Any one of the things listed above could spark a stock market crash, or it could be something no one ever saw coming. And there are other risks that some see coming, but no one listens or invests in preparedness. So what is an individual investor to do?
What Casuses a Stock Market Crash?A stock market crash is a social phenomenon. It is a human-created series of events triggered by economic factors and crowd behavior psychology. Stock market crashes happen when these 4 factors occur together:
- Stock market prices have been increasing for a long time.
- Everyone is overly optimistic about the future.
- The P/E ratio of the market today is higher than the historical averages.
- People borrow money to buy things at a high debt-to-equity ratio.
ReadyFor401k’s Analysis, SEE RELATED:
Crashes, the chance of a lifetimeIn an ideal world a crash would occur right before you invested a ton of capital into the market. In other words, you would be buying tons of assets on a bargain sale. This is what Warren Buffett means when he says “be fearful when everyone is greedy and greedy when everyone is fearful”. When the masses believe the sky is falling and start selling in panic mode, quality assets can go on sale. Every crash or correction is an opportunity for patient investors to make money. Every huge drop in the stock market (major indexes) is erased by a bull-market rally. When the next crash does occur, the following five high-conviction stocks can be confidently bought hand over fist.
When Things Crash, Remember The Time Tested RulesMarkets go up and down, up and down. But value is mainly made over long periods of time through diversified accounts of quality companies, such as through Vanguard “Boglehead” Investing. Remember the old Graham quote:
“In the short run the stock market is a voting machine, in the long run it is a weighing machine”Public and popular opinion is fickle and subject to herd mentality. It doesn’t matter in the moment what the herd is thinking, it matters if a company provides value and turns a profit. It is just a natural way of the Universe of building and destroying and building and destroying… Not even the ancient pyramids are forever, they too are disolving into dust in spite of the Kings mustering the forced labor of millions of people. Over long periods of time, high quality assets go up in value because they provide value to others. If the asset provides value then it will rise in value again someday.
Steady Recovery from 2008By 2012, the United States stock market is on the upswing. Between 2010 to 2017, the stock market price increased by 215%, which is an average of 12% growth rate every year for over eight years. Toward the end of 2017, the United States government passed a sweeping tax cut that among many changes, cut the corporate profit tax from 35% to 21%. The new law sent the stock to an all-time high, again. Many smart people thought the 2008 recovery maxed out by 2016. Little did they know that 2016 is only the start of another bull run!
Should I Sell?Based on several metrics, it seems the stock market is overvalued or “fully priced” as of today. Should you sell? Here is the nuance. If you think the market is over valued and a crash is coming, then perhaps the right move is to ensure your portfolio is designed to withstand shocks. Or, you could rest assured that historically every single crash has resulted in growth of the market over the medium and long run. Why and When Do I Sell Anything? I sell when I require the capital for other uses or to re balance the portfolio, not because I think some crash is imminent. Below, I’ll give you four reasons why you should never try to act smart by “buying low and selling high” no matter how confident you are:
- Stock prices are statistically proven to be RANDOM.
- It’s IMPOSSIBLE to time the market (might as well call it gambling).
- Being optimistic OR pessimistic about the market hurt us equally. Solution? Don’t feel. Inaction is the best action.
- Over the next decades, stocks will always go up more than they go down.
Why Does It Always Recover?There are several major reasons the market in general always recovers. Life basically always goes on. Unless we are wiped out by a meteorite, alien species or climate change; the economy will just continue to churn. People want to eat, live, build, have fun, make new things, add value, raise families. All that stuff takes thousands of products and services.
After years of investing and talking with many self-made wealthy people, I am convinced that we all get about 3-4 big financial opportunities to make quantum leaps in building our net worth. In order to reach F.I.R.E. we need to leverage each one of these opportunities. And it seems that many times these opportunities occur when it seems like everything is crashing down around us. Are you preparing now to be able to jump on the next opportunity?