Next Bear Market Will Catch Investors Off Guard
Stocks are soaring, and the U.S. economy is chugging along. This has led to investor complacency. In fact, investors haven’t been this complacent since 2007, just shortly before the stock market crashed and the U.S. economy slipped into the Great Recession. Having no fear in the markets does not mean stocks will enter into a bear market or crash, but investor complacency coupled with soaring stock valuations means that many investors will be caught off guard when the next bear market does happen. And when stocks do start crashing, it will devastate investment portfolios.
The S&P 500 remains bullish. In fact, come March 2018, the current bear market will be nine-years old. It’s already the second oldest on record and has not recorded a correction of at least 20%.
This has fuelled investor optimism to record levels. The CBOE Volatility Index (VIX), better known as the “fear index” is at its lowest levels since 2007. Investor optimism meanwhile is at a seven-year high. This means investors are certain stocks will continue to rise and are pretty much, fully invested. What this also means is that when the markets do start to correct, everyone will be heading for the exits, further exacerbating the crash.
How far will stocks fall? Impossible to say. But we can look at stock market valuations to see just how overvalued stocks really are. And what could happen when the next bear market come roaring back.
The most popular measure of stock market valuations is the Case Shiller PE Ratio. It compares the valuation of inflation-adjusted earnings of S&P 500 companies over the last decade and assess whether stocks are cheap or expensive relative to their long-term averages.
Right now, the Case Shiller CAPE P/E Ratio is at 34.16; the long-term average is around 16. That means stocks are overvalued by an eye watering 113.5%!1
Consider, U.S. stocks have only been this overvalued once before. In December 1999, during the height of the dotcom era, the index hit a record 44.20. Think about it, stocks are more overvalued than they were in 1929. In September 1929, just before Black Tuesday, the index was at 32.56.
It doesn’t end well when stocks are this overvalued. In 1929, the markets crashed and we entered into the Great Depression. In 2000, tech stocks were overvalued and investors didn’t care. The markets crashed. It took 15-years for the NASDAQ to surpass its March 2000 highs.
That doesn’t mean the markets won’t trend even higher than where they are at today. The last time U.S. equities were this overvalued was in February 1998; the markets continued to climb higher for almost two more years.
So, there is more room for stocks to run. But that also means stocks are going to have that much further to fall. Investors that do not crash-proof their retirement portfolios could see their nest egg get hammered.
Even a 20% correction, which is not uncommon, would only send the markets back to where they were at the start of 2017, the month Trump took over the White House. A correction of more than 20% is a lot more likely.
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The stock market moves in cycles: boom, bust, repeat. Bear markets, a decline of at least 20% from their peak, are not uncommon and have occurred 32 times since 1900, or once every 3.5 years. The last time the current bull market had a 20% correction was in 2009. A bear market is coming and when it comes, it will hammer stocks that are at present, overvalued by 113%. Fortunately, the professional traders at Learn-To-Trade.com
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- “Online Data Robert Shiller,” Yale University, last accessed January 22, 2018; http://www.econ.yale.edu/~shiller/data.htm
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