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.