2016 was a great year for the stock market.
The S&P 500 grew by 9.5% in 2016. It was the 8th year after the 2008 recession yet the U.S. stock market continued to rally. Every year since 2011 people have been crying about the coming of another stock market crash; had they listened to their advice they would’ve missed out.
They were right to worry, though. The stock market goes up and down according to business cycles, and business cycles crash every 7 to 12 years. How can we assess whether 2017 (the 9th year post the recession) will be the year of the crash?
The simple answer is: we don’t know. What triggers a crash during previous business cycles is not going to trigger a crash during this business cycle.
The best way to avoid losing everything from a recession is to keep doing what you have been doing.
Continue to save at a regular pace, and you will be totally fine and winning big in the long run.
What is the best market “crash” indicator out there today?
Indisputably that would be the S&P 500 Shiller P/E Ratio. The Shiller PE ratio is unique in that it (1) uses the annual earnings of the S&P 500 companies over the past ten years, and it (2) adjusts all the numbers to today’s dollars, with inflation adjusted using the CPI (Consumer Price Index). These two factors make the Shiller PE Ratio less volatile and more comparable about the standard P/E ratio.
The chart below displays the historical Shiller P/E Ratio from 1880 to 2017, courtesy of www.multpl.com. As of MLK day (1/16), 2017, the Shiller PE Ratio is at 28.13. The last time the Shiller PE Ratio was above 27 was October 2007, the beginning of the recent financial recession. There have been only three times in history in which the Shiller P/E ratio remained ed above 27 consistently, in 1928 at the start of the Great Depression and the stock market crash; in the late 1990s at the height of the dot-com tech bubble; and the 2007 global financial crisis. Sounds scary and a sure sign of the pending doom, doesn’t it?
Does this mean a crash is coming? Not necessarily.
Remember that the Shiller P/E Ratio in 1996 was also above 28. Had you stopped investing, you would’ve missed one of the sharpest bull runs of the stock market history. The world is very different today than it was 25 years ago. The Information Age that has swept over us in the past 25 years is nothing like we’ve seen before. Today, companies can be consistently unprofitable for years while they build up the “intangible assets” and “ecosystems.” Amazon has not made money in awhile, but there is no dispute that Amazon has taken over our households, transformed the retail industry and a great stock for anyone to invest in the past decade. Having built products at Amazon, I know how incredibly smart and hard-working the employees are, and I am more than happy to put my money with these guys.
The market will correct. But attempting to time the correction is just a gamble. If you need some short term fun, go to a casino.
Times have changed, perhaps. Or times have not. You will never know. Keep investing. Keep saving. Keep diversifying. And if you are still bored, make more money.