Hang around the world of finance very long, and you’ll see history repeating itself, especially when it comes to financial news articles. When it comes to a stock market in the middle of an extended rally, all manner of financial and investment analysts turn into Professor Trelawney, seeing the Grim in every cup of tea. The longer the rally goes on, the more pundits who join in predicting a stunning market collapse.
The reason is that doing so, is a low-risk way to get your name in the papers, and, if you get lucky, to be labeled a guru based on “predicting” the inevitable stock market crash.
Remember the analyst who predicted the muni bond crash that never happened?
Neither does anyone else, but she built up quite a lot of business based on that publicity before everyone forgot all about her. (And, before she changed her story.)
Of course, you can make a name for yourself the other way. Back during the internet bubble, one analyst earned a reputation for “always being right” about the market going higher. She predicted it would go higher quarter after quarter, right on through the top…
and after the top…
and even called for “buying the dip” as the market crash began.
No matter. She was the top strategist at Goldman Sachs for the next two decades where she predicted an UP market every single year until stepping down. I guess a stopped watch is right twice a day.
The reality is that the press likes a good prediction story, especially if it is a scare story, super-especially if it is a contra-scare-story.
Of course, these days, people predicting a market decline are a dime a dozen and you have to wonder, are they right?
Overvalued Stock Market
The catch to predicting the stock market is that not only do you have to be right, but everyone else has to know you are right too.
In 1999, as numerous analysts, and Alan Greenspan, warned that stock prices were not only overvalued, but no longer tied to reality, stocks still kept going up. The stock market is not a magical indicator of true value. Rather, it is more like a popularity contest where investors try to predict what will be more popular at a future time.
The value of Apple, as measured by market cap, varies by millions of dollars every day despite Apple’s product line-up, sales and expenses being mostly the same as yesterday. Do you actually think that the company’s true value changes that much day by day, or even month by month? What changes is the ratio of people who want to own Apple versus the people who want to sell Apple.
Theoretically, over the long term, the stock market does fairly value assets. However, that is very much a function of returning to the mean. The catch is that you never know how long the market will stray from “true value.”
In fact, in a very real way, the stock market is an indicator of the future prospects of the U.S. economy, relative to a specific company. For example, if Apple makes a great new iPhone it will sell well. How well it sells is both a function of how good the phone is, AND how much money people have to upgrade to the new phone.
For people saying the market is overvalued, the point is that the current economy, and the projected economy don’t add up to saying that companies are worth as much as their current share prices. But, remember for the market to go down, it doesn’t matter if that is true; it matters if investors BELIEVE that is true.
The concept is that eventually those who are wrong will realize their mistake. However, that can be a long time coming. In some cases, circumstances can change before anyone realizes they were wrong, and then the market never corrects at all before heading up an a different set of circumstances.
How To Protect Yourself From The Coming Stock Market Crash
First off, remember that a market’s valuation can correct without crashing. A period of sideways movement allows fundamentals to continue to rise toward the “right” valuation without any kind of downturn at all.
More commonly, a market correction, a slow decline in values also can bring fundamentals in line.
The reality is that crashes often take more than simple overvaluation to occur. The recent “Great Recession” was caused by a combination of the Fed raising rates too aggressively, coupled with banks having overleveraged themselves, combined with that overleveraging being pushed into Mainstreet America in the form of home loans that teetered on the edge of repay-ability. When, one domino fell, it took the whole economy, and stock market with it.
Even the internet bubble popping back in 2000 can be tied to tighter monetary policy, resulting in a more difficult climate for unprofitable business to borrow money to stay afloat. Once they started going bankrupt, they took a lot of money with them, and the markets ran scared. THEN everyone believed that stocks were overpriced, but not before an external pinprick hit the pricing balloon.
Today, the Fed is raising rates again, but being fairly cautious about it. While a trigger may be out there, that trigger will be something OTHER than just stocks being too expensive. Once that trigger happens, then, and ONLY THEN, will investors believe that stocks are overvalued and sell.
The best protection for long-term investors, as always, is to own a diversified portfolio. If you are worried about a market downturn, don’t change your investing strategy, just rebalance your portfolio. Either way, keep buying. Buying while stocks are headed down just means getting them cheaper and cheaper. When things turn around (and they always do), your returns will be much higher than if you tried to guess when to get in and out.