Lazy Man and Money

Stay Safe a Stock Market Bubble/Crash

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Stock Market Crash

It may be time to prepare yourself for this stock market bubble to crash. Have you looked at your investments lately? Some people say that it’s good to just set and forget it with a few index funds and steady automatic deposits. Twice a year, check the asset allocations and see if they need to be rebalanced.

That advice should work well for most people. It doesn’t work as well for someone who writes about money nearly every day like me. I look at the stock market a lot. Overall, I know I should be invested in the stock market for the next few decades of my life. This is one of those times that I’m finding it difficult to stay invested. Last January (2020), I realized that in the previous decade our investments had quadrupled. That made me nervous that we might have a market crash. COVID hit, and we did have a short market crash. Now our investments are up another 40% from there.

I like seeing the big numbers when I log in, but now I don’t want to lose them. How do you stay fully invested and still prepare yourself for a stock market crash? That’s what I wanted to explore today.

Is the Stock Market in a Bubble?

In my opinion, the stock market is in a bubble. I’ll make a case with a few examples below, but it’s important to understand that this is my opinion. There are plenty of expert opinions out there who say that the economy is doing very well and it’s only looking brighter with summer and more vaccines. (Of course, there are the new variants of COVID, so maybe not everything in the future is looking rosy.)

If you don’t think the stock market is in a bubble, you don’t have to do much. Also, if you are in the stock market for decades, you may not care either. I don’t know if a crash has ever lasted long enough to derail that plan.

For now, let’s just assume that the stock market is in a bubble.

What Causes the Stock Market to Crash?

The stock market can collapse for quite a few reasons. The usual themes are people being overconfident that the stock market will make big returns (sometimes 20% or more) year after year. Here are some of those reasons why a stock market crashes.

Speculation

One reason stock markets can crash when people feel like they simply can’t lose money. That’s when people make crazy bets that make no sense. There were a lot of these around 2000 when internet stocks were all the rage. You can see some of this today with meme stocks like GameStop. Or as the kids say today, “STONKS, only go up!”

Too Much Leverage

Sometimes people borrow too much money and have trouble paying it back. This is what happened in the sub-prime mortgage crisis in 2008. (There was more to it, but this is the simplified version).

In the 1929 crash, people borrowed money to invest and when those investments stopped making money, it collapsed.

Macroeconomic Conditions

That’s a big word for what I like to call “juiced markets.” Certain economic policies by governments can create a favorable environment for buying stocks. Recently, we’ve had a big combination of these with quantitative easing, low interest rates, tax cuts for corporations (allowing them to buy back stock to boost stock prices).

These “juiced” market conditions help the markets go up and stay up. However, it’s hard for them to continue forever. It’s just not sustainable. When things go back to normal there’s a risk of a drop in the stock market.

Political Risk

Fortunately, the United States is in a fairly good place politically. I don’t think we’re going to get involved in any wars soon and we’re building back relationships with our closest allies. Also, to some degree, the world is united to fighting a common foe, COVID.

Stock Market Panic

Sometimes one or more of the above things cause the market to go down. When people see this, they get worried that they are going to lose their money and start to sell. This can cause prices to go down further. The snowball effect of selling and low prices grows and grows.

“When is the Stock Market Bubble Going to Crash?”

I’m so happy you asked this one. My kids ask questions like this and I answer them, “On one of the days that end in -day.” I’m full of bad dad jokes that annoy them to no end.

The truth is that no one knows when the stock market is going to crash. My crystal ball has been at the repair shop for years.

However, if I were to try to read the tea leaves, I’d say that there’s a lot of over-speculation going on. The classic example is GameStop, but you can also see that people have become accustomed to 20% gains for around a decade now. Even when there are sell-offs such as the one at the beginning of the pandemic, they don’t last long because people come in to buy more stocks while they are cheap.

It’s impossible to know when a bubble is going to pop because the market can always go higher. There’s no magic number that signals to everyone, “Start selling now!”

So do you just give up because it is impossible? No. There are indicators that can help you know if the stock market is in bubble territory. Here are a few of them:

1. Shiller P/E or CAPE

My favorite indicator of a possible stock market crash is Shiller P/E or CAPE. It’s the raio of price to earnings. If you look at the graph you’ll see some sharp spikes around certain dates:

Shiller PE

You can see the rise in stocks in the “Roaring 20s” leading to the “1929 Crash.” More recently, you can see the crashes in 1987, the dot-com bubble and bust, and the great recession of 2008.

What you may also notice is that the stock market doesn’t stay above 25 for long without a crash… except for the last 5-6 years. We’ve been averaging being above 30 during that time.

A case could be made that there’s a “new normal” of stock investing that wasn’t available in the 1920s or 1987. I can believe that argument, but I think that pushes the market to a 25 P/E. Another line of thought is that earnings are low due to the pandemic and that prices are looking forward to the future when they recover. I can believe that as well. You can even blame TINA.

However, these are all justifications for what we can see clearly, stocks look historically very expensive.

Again, this doesn’t mean that a crash is coming tomorrow, next week or even within the next year. The market could continue to go up for a long time. However, it seems historically likely that you’ll have a chance to buy stock cheaper than this within a few years.

2. Buffett Indicator

Another way to measure whether the stock market is overvalued is to use the Buffett Indicator. This is the ratio of total US stock market valuation to Gross Domestic Product (GDP). The website Current Market Valuation has a great graph of this over time.

Buffett Indicator

The (much oversimplified) theory is that if the stock market has gone up a lot and we aren’t producing more product, that’s not a great sign over the long haul. The website above does a much better explaining it in detail. It also explains that the markets may be particularly high now due to low interest rates and other “juiced market” factors that I mentioned above.

As you can see the indicator shows that the stock may have been more overvalued than it was in the dot-com bubble.

3. Household Equity Percentage

There’s a third indicator based on household equity percentage. I don’t have a recent chart of this. The first two indicators were enough to validate what I was feeling. More information on this can be found at that last link.

How to Keep Your Money Safe in a Stock Market Crash

I’ve been fortunate enough to have blogged through the 2008 crash. At that time, my wife and I were 30 years old, with decades of earning and investing. Here are a few tips that I’ve learned and what I’m actually doing with my money now.

Diversify Your Investments

This is said so often that I feel like people take it for granted. It’s good to have broad-based index funds. However, I often see people focus their investments in the United States. There’s a whole global economy out there and some stock markets may not be as juiced as others.

Additionally, the main index funds for the United States have a lot of technology stocks. I love technology, but I saw how they crashed in 2000. I don’t see a similar thing happening to Apple, Google, Amazon, Microsoft, or Facebook, but a lot of those stocks are under heavy pressure from countries all over the world simply because they’ve become more powerful than the governments of many countries themselves.

Because of all this, I recommend removing tech risk from your portfolio. I did this and I still have a lot of tech risk in my portfolio. I don’t make big changes in my portfolio all at once, so it takes a while for me to shift some investments.

This may be a good time to explore REITs, gold, maybe even a little bitcoin. I’m a big fan of REITs, but not so much the other two. With people doing more work from home, I’m less excited about REITs that may have office buildings.

Switch to a More Conservative Asset Allocation

Last February, I sold off some stocks and bought more bonds – but it wasn’t much. I was still about 90% stocks and 10% bonds. I wanted to preserve those big investment gains of the previous decade. When the COVID crash happened, my portfolio dropped a little less than the major stock indexes. It was still a very big drop. However, I was able to sell off the bonds on the way down and buy more stocks until I was about 100% stocks. Now with the stock market at new records that move looks to have paid off.

What I’m going to do differently now, is have more than 10% bonds. It’s hard because bonds aren’t paying good interest rates now. It’s still the best way I know to stay invested and not lose your shirt in a stock market crash.

Invest in More Dividend Stocks

I took a large amount of the money that I typically allocate to the United States total stock index (an ETF under ticker symbol VTI) and moved it to a high-dividend ETF under HDV. HDV has less technology and more boring companies that tend to make money and pay dividends. I think this is a more defensive way to invest.

Unfortunately, HDV wasn’t ideal to protect against a COVID crash because it has some big oil companies. If it had been around during the tech crash of 2000, I think it would have done a lot better. It likely would have done better during the Great Recession of 2008-2009.

Final Thoughts on Stock Market Crashes

Do you think the stock market is going to crash? Do you actively look at or think about these things (or is it just a personal finance blogger thing)?

(I realize I may have shifted from “my” and “our” portfolio a lot in this. I actively manage my own portfolio while my wife passively manages hers. Only at our monthly net worth meetings do I have visibility into her side of things. It’s further proof that passive investment is just fine.)

How We KNOW Where the Stock Market Will Go

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I often don’t like to predict the future… my crystal ball is perpetually in the shop. Let me rephrase that. I love to predict the future, but I’m not particularly good at it.

sliding stock

It’s easy to throw around predictions. (In fact, I’m going to throw out a prediction for this Sunday’s sporting event later on this week. Spoiler Oliver has MVP pedigree)

The stock market is the same way, right? You can’t know where it’s going?

These Two Tools Seem to Predict the Stock Market Extremely Well

I might have been a little over optimistic with the capital “KNOW” in the title, but I wanted to create separation from just any old prediction or guess. Let me introduce you to two friends of mine.

1. Shiller PE or CAPE

Back in 2012, I asked How Expensive Are Stocks Now? I wrote that Dow 13000 made things seem expensive. In short, I feel for an absolute number that didn’t really mean much (just like Dow 20,000). A reader pointed me to a historic graph of price/earnings and I learned how to use Shiller P/E as an indicator of relative value of the stock market.

At that time, both of those indicators actually showed that stocks were fairly cheap, because they had great earnings. In fact, my chart showed the Shiller PE 10 to be around 16.51, which very close to its mean. The higher the Shiller PE number, the higher the price/earnings ratio, which isn’t usually a good value. (Sometimes people call the Shiller PE, CAPE)

Today the Shiller PE sits at 28.16, which looks to be pretty close to the crash of 2008. The other times it was this high was the crash on Black Tuesday in the 1929 and the Dot-Com crash around 1999-2000. It’s not too hard to see a trend here, is it?

I’m not saying that we are headed for another crash (stock prices going down), but we could have a long period where stock prices don’t go up while earnings catch-up. Either one would bring the number in line with where it historically is.

2. Household Equity Percentage (HEP)

I hadn’t heard of HEP until recently when I read The Single Greatest Stock Market Predictor Is… What?.

Here’s how HEP is explained there:

“HEP gives us a measure of what share of household finances are invested in equities. And that figure can be used to render some statistically solid conclusions about the long-term future of stock returns.

The figure is calculated by taking the dollars held by U.S. households in stocks and dividing by the quantity of household wealth held in stocks plus bonds plus cash.”

Financial Libre goes into extensive detail about why the measure should be less valuable flaming bag of crap, but then you see the chart and there’s a patented Keanu Reeves… WHOA? Then Financial Libre gives you details on why it appears to work despite all the flaws. It’s a cool enough read that I’ll link to it again for you.

The big takeaway is that there’s a second tool that seems to be great at predicting where the stock market is going to go.

Let’s Put Them Both Together!

Both the HEP and Shiller PE indicators make the United States look like a poor place to invest in the next decade. People who have been previously used to getting 7-8% returns might have to settle for 2-3% returns.

If you had $500,000 invested, you might (rule of 70) guess that you’d end the decade with a cool million. However, if we use the lower-end analysis, you might end the next ten years with around $610,000. That’s a big difference if you have a good amount of money involved.

So where do you go from here? That’s a great question. It might be time to explore some of those foreign stocks that have been under-performing for the last decade.

What do you think? Let me know in the comments.

Investing Tip: Focus on Accumulating Shares

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The stock market is down nearly 7% to start the year. For the first time since 2008 it looks like the bull market will give way to the bear market. I imagine a lot of investors are nervous. I get it. It’s scary to see a large loss of money in such a short time.

I try not to look at the money. That may sound silly considering that money is the whole point of investing.

Instead of looking at the money, I try to accumulate shares of index funds and, occasionally, individual good companies. This focus leads me to react differently to a market downturn.

I look at companies as being “on sale.” For example, I’ve been an investor in IBM for almost two years now. I had made money at first, but the stock dipped and dipped. I’ve been dollar cost averaging into it and accumulating shares. A lot of investors don’t like the (lack of) growth at IBM. I like that they’ve bought back shares an trade at an extreme low 9 P/E while paying out 4.24% a year in dividends. To be able to buy such a company “on sale” is seems like a great opportunity. Wal-Mart is another company that I’m buying at what I feel is a cheap price (by P/E metrics) with a good dividend yield.

I can buy more shares of IBM and Wal-Mart now than I could a year ago. I can buy about 25% more of them on average. I think about using my money to acquire the most shares possible. My money buys me 25% more shares than it did in the past. I’m being careful with how much I put into individual companies, because I remember buying Lucent and Worldcom around 2000. In such scenarios you don’t necessarily want to have too many shares.

This idea extends investing in indexes too. Typically index funds are less volatile and unlikely to fall to zero. An example of what I’m doing is buying more shares of foreign stocks and emerging markets through index funds. The strong dollar allows me to buy more shares of these indexes that are beaten up. I’m very confident that sometime in the next 10 years, I’ll be very happy to have a lot of those shares and the opportunity to sell some high and buy other assets that are “on sale.” I’m not tied to a 10 year timeline, these assets are ones that I’m planning to use in retirement, which may be 70.5 if my other income streams continue to support me.

Warren Buffett is known for saying, “Be fearful when others are greedy and greedy when others are fearful.” I think this is the time to be greedy in some areas and that means taking advantage of the timing to own more shares with the same (or even less) money.

Use Your Gas Savings to Save and Invest

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Yesterday, I was running an errand and I noticed something different about the local gas station. The prices they were advertising no longer started with a crooked number. Gas was $1.999 (I’m going to acknowledge that weird 9/10 of cent they sneak in there.)

In much of the country this is old news. And in other parts of the country the price still starts with a crooked number.

The point is that it was a catalyst for me to think about how low gas prices have gotten. If you work in the energy industry, this is a bad thing. I’m sorry for you. I feel a little of your pain as I’ve been buying oil stocks (ticker: USO) when it was more than twice the price it is today.

For everyone else, low gas prices probably mean you have some extra money left over each week. You could use this money to support the local economy (a nice meal out perhaps), but I’m going to suggest something different and very predictable:

Save and Invest it.

If you have a brokerage account already set up, you can probably automate $50, $75, $100 a month into it. Personally, I like to use My Dobot account as I can text “save $50” and be done with it. With the way Dobot works, it’s already saving money. To read more how Dobot works read my review.

It might not make sense to buy a stock with $50 as commissions can eat up a large chunk of that. You can set up an automatic deposit with a lot of mutual fund companies to avoid this.

You might be thinking that $50 or $100 a month isn’t going to add up to much. (Quick math: that’s $600 or $1200 a year.) Depending on your current financial state it may not mean much. It’s all relative right? Bill Gates is certainly not going to care too much.

However, it may mean more than you think.

The stock market has been moving down since the start of the year. This means that you can buy some stocks on sale. (Full disclosure, I’m pimping out the IBM stock that I own. It’s trading at 2008 prices with a P/E under 9… and it pays a great dividend).

It’s a perfect match. You have extra cash from the low gas prices and the stock market is low so your money buys more shares.

If you want to double dip, you can do some of what I’m doing and buy oil stocks with your savings. I’m not sure you should be investing in USO like I am (I’m starting to think I shouldn’t be investing in it), but some of the big gas companies like Exxon and Chevron could be safe bets. The beauty of this idea is that if gas prices recover and you can no longer put that extra money into those companies, you’ll be happy to see their stocks have very likely increased as well. It’s easier to pay more at the pump if you know that you are getting it back in your brokerage account, right?

What are you doing with your extra gas money? Let me know in the comments.

Devil’s Advocate: Give Me A Stock Market Crash!

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Last week, I put forth a Devil’s Advocate argument, Give Me High Gas Prices! The crux of the argument is that high gas prices spur demand from consumers for more fuel efficient cars, which in turn spurs more car manufacturers to fill that demand. The end result is that we get cars with outstanding MPGs, at which point, I can wish for low prices. My dollar goes further and it’s better for the environment. Cue the puppies, ponies, and rainbows!

A commenter brought up that of course it isn’t that simple. It never is. Nonetheless, I still believe there’s a good correlation there.

So this week, I’m going to make a devil’s advocate request for a stock market crash. Why on earth would I do such a mean and crazy thing like that?

I want to buy stocks on sale. I like paying between $17-19 for Facebook. I don’t like paying $45. I like paying in the $500-600 range for Google. I don’t like paying $900.

I’m a frugal guy and like to buy things on the cheap. With the S&P 500 recently climbing to all-time highs, I’m not finding a lot in the bargain bin. I’ve got some cash looking for a home and I can’t find anything that I know and trust at a great price.

I realize that I shouldn’t be so sensitive to the prices. After all, the underlying metrics like earnings are what matters, right? Well stocks look expensive according to the Shiller PE that takes earnings into account.

It may sound crazy, but in my ideal scenario, we’d have the exact inverse relationship to the gas scenario that I mentioned above. Stocks would stay low and for an extended period of time, while I build up a ton of shares. Then we’d see a huge spike and I could sell for millions.

One can dream right?