Almost always, one is wrong before being right. Elvis Presley recorded dozens of duds before becoming one of the top-selling musical artists. Michael Jordan missed thousands of shots before becoming an incredible legend in the arena of basketball.
Roughly a year ago, I warned that stocks are bound to fall. In the time since, stocks have risen an incredible 19.4%. The fact that I have lost money and those who believed opposite of me were correct does not mean I am wrong. It means I am closer to being right. Below, I will detail why we are closer than ever to a devastating bear market and how you can prepare yourself.
In my post one year ago, Stocks: Investment Outlook, June 2016, I warned the price to earnings (P/E) ratio was ridiculously high. In layman’s terms, stock investors were paying far too much for stocks. The Shiller P/E ratio was 26. This means that, on average, investors coughed up $26 dollars for every $1 that companies earn in a year. Does that make sense, to pay $26 dollars for $1 of profits? I don’t think so. In fact, over the entire history of the stock market, investors paid only $16 for every $1 of earnings, on average. By this metric, the stock have to fall nearly 40% to reach the historical average. In reality, stocks fall far below the average before rising again.
That was a year ago. Where are we today? Today, the Shiller P/E ratio is 30. This means investors are paying an uncanny $30 for every $1 of company earnings in a year. How many times has the Shiller P/E ratio been this high in the 140 years of data? Exactly once: in the 1999 tech bubble. Stocks are as expensive as in 1929 before the Great Depression. Stocks are far more expensive than in 2007 before the Great Recession. Stocks are far more expensive than before the 50% “Black Monday” market crash of 1987. Stocks would have to fall about 50% to return the the long-term average P/E ratio of 16.
Besides ridiculous stock valuations, other massive factors threaten the stock market: political stagnation, geopolitical risk, and the Federal Reserve’s actions.
Firstly, the 20% gain in the stock market in the last year resulted from the election of Donald Trump, or, specifically, his promises of huge tax cuts. Investors gobbled up shares in hopes the President would push through massive corporate and personal tax cuts, benefiting companies and thus stock prices. In contrast, Washington behaves as slowly as ever. Although Republicans control the Presidency, the Supreme Court, and both branches of Congress, polticians have accomplished close to nothing. Internal struggles within the Republican Party prevent anything from being passed. Corporate tax reform will not come nearly as soon as investors thought. When investors realize this, stocks will plummet.
Secondly, geopolitical risks are more extreme than any time since the Cuban Missile Crisis, yet investors are completely ignoring them. We bombed Syria, and Russia said doing so expands the chances of war. World War. Stocks barely flinched. North Korea tests nuclear missiles that can reach the United States and obviously one of our greatest allies, South Korea. Even China turned their back on North Korea. The stock market never reacted. Every day, terrorists attack Western countries. An attack on the scale of 9/11 could happen any day, but investors are not accounting for the geopolitical risks in the world. When something finally happens, stocks will crash.
Lastly, the Federal Reserve is rapidly increasing interest rates. As we know, savings accounts and other cash-like assets are risk-free (ignoring inflation). As the Federal Reserve raises interest rates, risk-free assets earn more money. Stocks are not risk-free. Risk-free assets look comparatively better because they earn more money than before and remain risk-free. Thus, people will begin to shift money from risky stocks to risk-free savings accounts and bonds. The Federal Reserve, in fall, will also begin to sell assets for the first time since the Great Recession. When they sell, supply will swell. As we know, increased supply leads to decreased prices on the financial markets.
We were close to a stock crash a year ago. We are now on the cusp. Nothing looks good for stocks. I expect within a few short months, a stock crash will begin. Now is the time to prepare. Invest in gold and inverse stock. You can avoid the massive losses of 50% or more and actually make money.
Time will prove that missing a few hoops or recording a few duds over the last year was only practice for what is to come.