That’s a title, I’ve been typing for at least the last 6 years. It’s usually only once a year and my answer has always been that it’s probably time to diversify with international stocks and bonds, REITs (Real Estate Investment Trusts), and other investments.
Let’s look at a chart to understand why my annual Chicken Little impression:
For those who don’t know, the Shiller P/E is a measure of how expensive the S&P 500 is. The S&P 500 is a good proxy for how the overall US markets are doing. It is calculated by doing the following:
Add up the annual earnings of the S&P 500 companies over the past 10 years. Adjust those past earnings for inflation using the Consumer Price Index (CPI). Average the adjusted values for earnings over 10 years. The Shiller PE is the current price of the S&P 500 index divided by those earnings over 10 years.
In short, the Shiller P/E gives you a great idea of where the market is valued in a historic context.
When I looked at the chart over the last six years, I noticed that any time the Shiller P/E got above 25, things didn’t go well. I’ve also noticed that 25 seems to have been at least the “new normal” since around the 2000 market crash. That crash was the only time that the P/E went consistently above 30. In fact, COVID brought the number back down to 25, which for some reason is only available on the table information.
In any case, you can see where the valuation is now in the chart above. It’s higher than before any crash. Could it get up to 50 and stay there? Perhaps. Could earnings catch up and bring it down that way. Of course. If the “new normal” is a baseline of 25, is >39 still too high? I think it is and it leads me once again to warn that a crash may be coming soon.
I got lucky last January and moved more money than usual to bonds before COVID hit. When it did and the stock market got hit, I sold those bonds, which hadn’t dropped much, to buy back into the stock market. It worked out well.
As the market continues to go up and up, I’m starting to get more and more nervous. I’m usually a very aggressive investor, but now I hold more bonds and cash than I ever had. I noticed that emerging markets didn’t have this same kind of run, so I’m investing there as long as valuations make sense. It’s harder to find Shiller P/Es of other countries, but here’s a source (Shiller P/E and CAPE are the same thing).
How To Diversify Now?
In the beginning, I mentioned that it could be time to diversify into international stocks, bonds, and REITs. I think those are core places to diversify. You may also consider the following: gold, cash, cryptocurrencies, and buying other businesses.
I haven’t invested in gold yet. I did invest in another business a few years ago, which has gone very well. I have some REITs, but I may buy more. I have also bought crypto, but I’m unsure about buying more at historically high levels. That leaves me holding more cash and bonds than I would ordinarily hold. In the grand scheme of things, it’s not a lot of cash and it is probably healthy to be more diversified in bonds.
What do you think? Am I being Chicken Little saying that the sky is falling once again? Or is it perhaps wise to acknowledge that it’s been a tremendous 11-year run and all good things will have to end at some point? Let me know in the comments.
You aren’t being alarmist, it’s just that the odds are against doing anything about it. Anything you do other than holding your current positions is almost guaranteed to make you lose money. You, me, nobody is smart enough to know when to get out and when to get back in. If you got out six years ago where would you be now? I share your concern but I’m sticking with the plan that got me here. If the PE drops back to 10, I’m fine.
I probably should have gone with a different title in retrospect. When I say “selling stocks”, I mean just investing in different things like bonds, international stocks, businesses, etc. If the Shiller P/E drops to 10 that’s a loss of about 75% of your stock portfolio (if you were all-in on the S&P 500). I wonder how many people would be fine if they have a million dollars go to $250,000. I think that’s super extreme, but I don’t think I would be fine with that. I think I would have wished that I diversified more. Also, having cash to invest at the new lower levels would be comforting.
I think it’s okay to be a little concerned, but don’t change your allocation too much. Maybe 15% at the most. Leave most everything else the same.
After moving stuff around and stressing out about it, I think the time to sell more stocks is about 2 years before full retirement.
For me, it’s easier to just let it ride instead of worrying about it.
I have a bit too much bond after diversifying in August. It’s crazy that the stock market keeps rising.
I don’t know about emerging markets either. I’ve been watching various videos about problems in China. They have a ton of problems – corruption, over-leveraged real estate market, aging population, young people don’t want kids, companies leaving China, etc… Not sure if they can continue to grow like in the past 20 years.
“ I got lucky last January and moved more money than usual to bonds before COVID hit. When it did and the stock market got hit, I sold those bonds, which hadn’t dropped much, to buy back into the stock market. It worked out well.”
I have yet to meet a personal finance blogger who didn’t take advantage of the March 2020 selloff! Everybody I know is up big.
Do you have a post on buying back then?
Here is mine, written on March 18, 2020. I would just keep on minting money.
I don’t think I wrote about buying back then. I probably left a comment on Retire by 40 above because we were both doing the same thing, buying in little increments because we didn’t know where the bottom would be. Most of the articles on this site were very brief because I was homeschooling two kids while my wife was virtually deployed to work on pandemic logistics.
Most of our retirement savings in is my 401k, with a small number of investment options. We have a small amount, a little under $60k, in an outside retirement savings. In 2018 I opened an account with a guy that is well known locally because he and I shared concern about what we thought was an overinflated market. The gentleman invested the small amount in “defensive” positions, and advised me on how to invest my 401k in more standard investments(still fairly conservative investments). My 401k is up over 50% since then, the defensive investment is down around 15%. So even though the market, but all measurable standards, should be down, it keeps going up. So it’s hard to be logical about investments that defy logic.