I’m not a fan of clickbait titles. This may look like a clickbait title, but it isn’t.
It’s an honest thought I had yesterday based on real analysis of more than 100 years of data. Seriously.
Here’s a current (3/6/2018) chart of the S&P 500:
Go ahead and click Image for larger version in a new tab. We might be using that later (Or click for the latest chart on Yahoo and make sure you select the Max number of years.)
It looks pretty good except for the dot-com collapse around 2000 and the sub-prime mortgage collapse around 2009. If those two events didn’t happen, it might look like a Bitcoin chart, right?
I’ve got another chart to show you. Regular readers might know what’s coming up. It’s:
Yep, the good-old Shiller P/E Ratio chart. (Sometimes it’s better known as the CAPE ratio.)
I’ve argued before that there is a crash any time it gets over 25. It may take a few years, but it seems to happen.
That’s all stuff that I have written about in the past. Here’s another piece of data to consider:
This means that currently the market’s price is nearly 33 times its earnings. Throughout more than a hundred years of history it’s been closer to 16.5 earnings (averaging the very close “mean” and “median” numbers).
If the market drops 50% tomorrow it would be at the historically normal valuation.
See, the title wasn’t clickbait, right?
Where Do We Go From Here?*
You may think from the above that I’m suggesting that you shouldn’t invest. I don’t think that and I still own about 90% of my portfolio in stocks. That portfolio is in retirement accounts, so I won’t be touching them for years and years anyway.
I think there a few things that may make you feel better from the dire math scenario I proposed above:
- Since around 1988, a solid sample size of 30 years, the Shiller P/E is 24.95 (using yearly chart data). Maybe advances in globalization, internet, better access to investing markets, etc. means that there is a “new normal” of Shiller P/E being 25? This time includes at least 3 crashes too.
So while 33 is still higher than 25 (my 5-year confirmed this math), maybe the downside isn’t 50%. Maybe it’s 33%. That’s still a big drop, but it’s got to be somewhat comforting, right?
- This is the S&P 500, which means they are American companies. You can invest in so many other places. I’ve increased my asset allocation in Europe and emerging markets. Their valuations aren’t as high and they seem to be performing well.
- This is the stock market. You can invest in bonds, real estate, commodities, and a bunch more stuff. I’m normally a very, very aggressive investor. I believe a smart plan is to be more conservative in your investing when valuations look high. I’m just going to be a regularly aggressive investor at these valuations.
I’d like to add one more personal note on the last point. I have been buying Twitter stock for quite a few years now. (I’ve written about it many times.) It was a terrible investment for quite awhile. It was really terrible. Overall, I’m up around 60% from what I paid for it. While that may sound great, the general stock market has probably done the same or better over that time.
Today, I pulled the trigger and sold some Twitter shares. I’m moving the money to my favorite bond ETF (Vanguard’s BND fund). It’s a very basic asset allocation shift towards being more conservative in my investing.
What are your thoughts on the market? Let me know in the comments below.
* If you know me at all, this a subtle nod to perhaps one of the best hours in television history:
At least now you can pay capital gains on your Twitter sales. ;) Stay the course I say. The market will do what it will do. One trick though…. make sure you translate your % loss in $ terms and not freak out. If you think you will, then you need to adjust your allocation to stocks to something more conservative until you’re comfortable with that (temporary) loss. The question I have is: how much, in absolute $ terms, are you comfortable losing?
I keep all my stocks in retirement accounts, so I think I’ll pass on paying those capital gains for now.
I did that trick to think about it in dollars and realized that if the market dropped by 50% tomorrow, our net worth would be where it was a couple of years ago. Other investments like real estate properties and paying off our own home give some diversity there. Of course, if the market drops 50% those would be effected too.
As you may be able to tell, I kind of convinced myself that 50% would be an extreme case and that the new normal could be “only” a 33% drop.
There are a lot of things that go into investment decisions. I lived through two big drops, saw some of the companies I invested in cease to exist, recovered, made money, but now that I’m in my late 50’s I’m not wanting to do that again, so I’ve adjusted by exposure. The fundamentals of the market are not strong and the government is adding debt at the highest rate in our history. Again, if you have time to take a 50% drop and make it back then do what’s best for you.
I’m sure as I get older, I’ll get more conservative. In fact, I think I already am more conservative than I was 10 years ago. It just makes sense and nearly every financial advisor seems to agree with it.
I’m concerned about some of the fundamentals of the market, but I think the new tax act will support it for awhile. It seems like there’s always something, whether it’s lowering interest rates, quantitative easing, new tax law, or bail outs. Maybe someday they’ll stop being able to come up with ways to prop up the market.
There is a gamechanger i used to miss too. The SP500 20 years back was owned over 80% by you and me, average people. Now its over 80% funds and investment companies. They act in other ways. Funds go for stocks as long as the return is higher than bonds. And since these funds are led by algortims they become fearless, reckless. Anyway read about it on my site rubendeprez.com . Enjoy