Most of the time, successful investing is a waiting game. It’s about picking the right time to buy and sell.
There are also times when you’re better off holding onto your cash while you wait for better opportunities.
When most investors are pouring money into the stock market as it continues to grow at unprecedented rates, I personally am sitting on the sidelines waiting for a downturn in the market.
While stock market crashes are rare, they are also inevitable. Investors who fail to keep this in mind end up being shocked when the market starts dropping — like it did on Monday, May 13th, 2019 when the Dow lost more than 600 points.
Here are the reasons you might want to consider a correction in the market and what you should do to protect yourself from losses.
1. The Market is Overpriced
From a valuation perspective, the markets are currently overvalued.
Investors and Wall Street alike have been optimistic about the market’s strength. This has encouraged investors to ignore the high valuations and put large amounts of money into the market.
Other contributing factors to overpriced markets include slowing global economic growth, U.S. and China trade tensions, U.S. policies and tax reform as well as the lack of attractive investment options.
Investing in indexes has become more a more popular given the lack of options. This causes prices to go up across the board rather than just for those companies that are performing well.
According to the Shiller PE prices have only been this high twice in the past 140 years. The first time they got this high was in 1929. The second time was in 1999.
When the market is overpriced, it becomes difficult to find quality companies to invest in.
2. Real Estate is Overpriced
Stocks aren’t currently the only overpriced investments.
In late 2017, the median home price in the U.S. was 32% higher than inflation. To put it into perspective, that median home price before the housing market collapse in 2008 was 35% higher than inflation. It serves as an indication of an overpriced and potential dangerous market.
The real estate market, like many other aspects of the economy, is tied to the stock market. When one goes up (or down) other aspects of the economy and stock market move with it.
3. Unsustainable Earnings Growth
Company earnings is also an important factor in evaluating stock health. If earnings fall, stock markets follow suit.
Investors have reaped the benefits of some spectacular earnings growth in 2018. But what goes up at unprecedented rates comes back down. Earnings growth will likely fall short of expectations in the future.
For the first 3 months of 2019, 76 of the 500 S&P 500 companies issued negative guidance about earnings. Only 27 of those 500 issued positive guidance. That means 3 negative earnings guidance for every positive one.
Even Wall Street analysts are becoming pessimistic.
Analysts expect growth of 0.2% in the second quarter, 1.7% in the third quarter, and 8.1% in the fourth quarter. Keep in mind that analysts tend to revise their earnings estimates lower, so it wouldn’t be shocking to see them lower their estimates in the coming months.
4. The Wilshire Index is Too High Compared to GDP
The Wilshire index is reaching extremely high levels compared to the country’s GDP.
What does that mean?
The Wilshire 5000 is an index made up of more than 6,700 companies. It is one of the broadest indexes and is designed to track the overall performance of American stock markets.
The GDP measures the value of economic activity. In other words, it puts a dollar value on all goods and services produced in the country.
Wilshire 5000 to GDP is a long-term valuation indicator made popular by Warren Buffet.
Simply put, comparing the value of the market to the value of the economy helps determine where the market stands at any given moment.
When the economy is being drastically outpaced by the stock market, it’s never a good sign.
5. Index Investing is Driving Money into the Market
The majority of investors today do not choose individual companies to invest in.
Rather, they invest their money into an index that may contain several hundred different companies such as the S&P 500.
The problem with this is that index investing drives up valuations across the board rather than just driving up the prices of companies that are actually performing well and backing up their high price with results.
In the end, this leads to a lot of companies with average performance to have incredibly high valuations – a recipe for disaster.
What Should You Do?
Stock market crashes don’t have to be bad for investors.
On the contrary, if you have cash, a stock market crash can open the door to some of the best financial opportunities.
Historically, crashes have rarely persisted for more than a year or two while periods of stock market growth have often lasted for many years.
Looking at stock market history provides a unique insight into why the stock market crashes. Here are the most famous crashes in history and what we can learn from them to help time the next stock market crash.
A crash may be your opportunity to buy stocks of great companies at low prices before they start climbing back up.
If, on the other hand, all of your money is in the market before a crash, you risk having little cash available to buy stocks when they are cheap.
This is why sitting on your money and waiting for a crash when valuations are as high as they are currently can be an effective strategy.
At Making Coins Count, we focus on investing in quality companies. These investments are solid enough to survive and thrive no matter the market conditions.
However, when a stock market crash drives prices of all companies down, including those of quality companies, the opportunity for returns is greater.
If you’re worried about stock market crashes, odds are you need to learn a little bit more about how to invest. I’ve got a free simple recipe to successful investing where you’ll learn how to protect your hard earned money from losses.
Will the stock market crash? What are you going to do if it does?