Today we have a guest post from Troy of MarketHistory.org on his opinion on what would be the best actions to take to help you save money during a market crash. Troy runs a small hedge fund during the day and in his downtime, he enjoys surfing and blogging. Read more about his blog here!
The current bull market in U.S. stocks and foreign equities only has a few years left. The global economy still has enough gas in the tank to grow for another few years (probably 2-4?). However, we will one day need to face the inevitable bear market, which historically has always seen the S&P fall at least 40%. Unless you want to see your portfolio crater 40% in just a few years, you should probably sell your stocks before the bear market hits. Here are a few ways to predict and sidestep the next market crash.
Long term valuations are crucial
An investor who doesn’t know how overvalued or undervalued the U.S. stock market is blind. And by “valuations”, we’re not talking about the media’s favorite line “the stock market is overvalued because everyone is bullish on stocks!”
Sentiment means nothing and is not a good long term contrarian indicator. Investors were “too exuberant” in 1995. Instead of predicting a stock market crash post-1995, global stock markets roared for another 5 years.
I am talking about valuation indicators such as Tobin’s Q, the S&P’s price-earnings ratio, and the S&P’s price-sales ratio. Each of these 3 indicators span decades, with Tobin’s Q going back to 1900 (117 years). They show you how overvalued or undervalued the market is in comparison with its historical peaks.
The U.S. stock market’s valuation is above its long term mean and is rather overvalued right now. However, it is nowhere close to its valuation levels in 2000, right before the dot-com bubble burst.
This means that this bull market still has some room to run in terms of valuation. But be very careful once valuation approaches 1999 and 2000 highs.
Do not pay attention to the media
This was an especially prevalent problem in 2007 and 2000. At the top of a bull market, the media will list every reason under the sun regarding why stocks can never fall. That is why you must block out all the exuberant voices from other investors telling you to buy, Buy, BUY forever!
At the top of the internet bubble, everyone was talking about the New Economy. Profits were such a quaint idea. Who needs profits when you can have eyeballs? Every tech company was saying “we’re going to revolutionize the world! We’re saving humanity! We’re changing the course of history!”
Few of them did and most of these companies died off.
Now don’t get me wrong. Some of these internet companies were great innovators and businesses. However there was a valuation problem. When a company has a P/E ratio of 400 and the long term historical average for stocks is a P/E ratio of 15, either the company needs to increase its profits by 26x or its stock price must fall 95%+. The latter is far more likely.
The valuations of many tech companies today are exorbitant. Tesla is now worth more than GM despite having nonexistent profits and producing far fewer cars. In addition, other automakers will soon challenge Tesla’s turf by offering their own electric cars. Although Tesla is a great company that’s highly innovative, it is insanely overvalued. These are the companies that will see their stocks crater in the next bear market.
Do not be lulled into a false sense of security by this bull market
Bull markets tend to lull investors into a false sense of security. Bull markets are long and gentle, meaning that investors have enough time to slowly sell their stock if they want to get out.
But many investors have forgotten how ferocious bear markets can be. The S&P crashed more than 30% from August-October 1987! In the heat of the 2008 financial crisis the S&P crashed 40% within a few months!
Volatility in this market is increasing because the global herd mentality has increased. When investors in the U.S. think stocks will go down, they try to squeeze through the same keyhole and sell all at once. Then the Japanese/Chinese see this, and they sell too. Then the Europeans jump on the selling bandwagon, thereby pushing prices down even more. And with the rise of computer trading, market swings are simply moving much faster than ever before. Days in which the S&P falls 5-7% have become increasingly common over the past 2 decades.
So when you decide to sell your stocks, sell them ASAP. Do not linger. Sure the stock might soar another 10-20% higher, but then it will crash 50%. Make a clean, clear cut decision to sell because the market might reverse fiercely any day.