Is the Stock Market Going to Crash Soon?
Dear Lifehacker, I’ve read a lot about how the stock market is breaking new records. Economists, Nobel Prize winners, warn that the market is overvalued. Does this mean that the collapse is coming? What should I do?
Best regards, intimidated investor
Dear Intimidated, Your question has several levels, but let’s start with the main one: Will the stock market crash? Oh sure. This is the easy part. Will it collapse now? Well … we don’t know that.
The market is always cyclical
As long as the stock market exists, it has gone up and down. In this Dow Jones chart, you can clearly see how the stock market has been constantly cyclically moving from 1900 to the present.
Two things are said about graphics:
- The market follows a cyclical pattern: it goes up, then down again, then up again, down again, over and over. Therefore, it is not difficult to declare that he will fall again – it always happens that way. Is always.
- The good news is that it always grows again, too. The news gets even better: As you can see from the chart, over time, the ups outweigh the downs by a significant margin.
Before we proceed, let’s be clear on what we mean by failure. The market never goes up in a straight line: there are always lows and highs as it usually moves up. However, there are a few drops that go well beyond what we might call “normal.” Two recent examples were the dot-com crash just after 2000 and the 2008 market crash. If you look at this Google Finance chart for the S&P 500, you can clearly see the difference between small dips and two large dips:
Now you can understand why it is easy to say that the market will crash – it always happens that way. The hardest part: when will it happen next?
The peaks are not equal to impending doom
No matter what they tell you, nobody knows when the market will go down. No matter how many degrees someone has, how many millions they have earned, or how many books they sold, the fact is that no one can predict the future consistently and accurately. For example, take a look at this stock market chart with dates removed. It just peaked, is it ready for a crash?
It is hard to say. You wake up in the morning and see the beginning of a small dip in the upper right corner. Oh dude! The market (as you can see) has been growing for a while, so is this the time it crashes?
As it turned out, no. Here is a continuation of the same graph. The dotted red line shows where that critical morning was when you woke up and wondered:
The fact that the stock market is at its peak is not a predictor of a major crash.
Of course, every drop is preceded by a peak, but not every peak is followed by a crash. In fact, as you can see from the chart above, there are hundreds of peaks followed by higher peaks. So don’t let anyone point you to the peak and claim it heralds ruin.
So what about those talking heads that keep predicting imminent doom , especially those who claim to have named the previous one? They play a game with math and memory. The math part says that if they say the market will crash every month, sooner or later they will be right (see above). Then (flashback part) they hope that you will forget all the moments when they shouted “wolf” and they will shout: “See! I told you the market will crash! You can buy my book on Amazon for $ 24.95. ” They may even try to sell you a subscription service for $ 2,000 a year. (Hey, if you fall in love with the book, who knows? You can’t blame them for trying!)
But for you a more serious question …
What should you do?
Now that you know you don’t and never know when the stock market crashes, what should you do? Or not?
Your hint is the first diagram. Take another look. The market is always recovering and making a higher peak. The only exception to this rule was the first big crash on the left, the big crash of 1929, which led to the Great Depression of the 1930s. The next peak is the only one lower than the previous one. All other peaks were higher than any previous peak.
This means two things to you:
- The market will recover. It always happens that way. It never happens that everyone is gloomy and gloomy, but it is. And then it goes even higher than before. If you just keep doing what you did before the crash, you will eventually recover and reach higher highs.
- Every time the market crashes, smart investors like Warren Buffett lash out and buy up all the possible trades (“Fire Sale!”). They do it with cash that is saving, and they don’t invest when the market is on the high side, as it seems to be right now.
High side? Really? How can you tell? Here’s how you don’t say it: the charts you looked at above.
What? We spend all this time looking at charts, and now they’re not what we should be looking at?
Right. At least so as not to determine if the market is overvalued. Let me explain.
How to look at the stock price
The numbers you see on the news every day reflect the market price, just as they reflect the price of a stock. But the price of a stock does not tell you whether it is expensive or not.
Let’s take two examples that I love to use: Apple and Whole Foods Market. Apple stock prices these days are around $ 120-130, while Whole Foods is around $ 55. So, is Apple stock worth more?
No, Whole Foods is twice as expensive, although at half the price. When evaluating shares, we do not look at the price in dollars, we look at the price that is a multiple of their profit.
Apple is trading at a PE ratio of about 17 times its earnings, while Whole Foods is trading at about 34 times its earnings. This means that you are paying twice as much for the Whole Foods Market revenue stream as you would for the Apple stream. This is why Whole Foods shares are twice as expensive as Apple’s. (And you thought that only what they sell was expensive.)
The stock market is nothing more than a collection of all the shares traded on it. Like individual stocks, the market as a whole trades at multiples of the returns of all of these companies. These days, the S&P 500 (the largest 500 stocks in total) is trading at a multiple of about 17 times the profit. So, is it high or low?
This is not what doomsday people like to hear, but the market PE ratio of 17 is pretty close to its historical average, as you can see from this graph:
The graph clearly shows how the PE market ratio went down (a scientific term, according to my cousin Vinnie ) during major market crashes. Now tell me: Is PE on the market out of order at the moment? I don’t think so either. (If you want to use the Schiller coefficient CAPE, first read the detailed explanation of this metric here .)
Again, no one knows what the future holds, but it’s hard to argue that the market is overvalued today despite new weekly market highs. Stock prices are high because companies are reporting high returns.
Regardless of whether the market is ready for a crash, the best strategy for most people is to just keep doing what they are doing now.
Regards, Lifehacker