When Will the Stock Markets Crash?

By in Investing, Mind and Money, Money Management | 7 comments

Are We Due For Another Stock Market Crash?

With the memories of the year 2,000 tech bubble bursting and subsequent stock market crash along with the more recent crash in 2008, many investors are worried when the next crash will hit. The S & P 500 has more than doubled since then. Investors’ are increasingly elated with their recent portfolio gains, and fearful of the future.

Recent comments about the potential for a stock market crash:

Many of my family, friends, and followers are asking these questions.

1. Should I reduce my  percent holdings in equities (stocks)?

2. How can I protect myself against a stock market crash?

3. When will we experience the next stock market crash?

Behavioral finance shows that we are not rational. We frequently invest based on irrational emotions. We get way too excited when markets are rising and frequently dive in after a big stock market increase. Then when the inevitable decline arrives, we jump out of equities at the bottom of the market.

These irrational, behavioral finance actions cause investors to buy high and sell low.

This article will discuss when the next stock market crash will occur, and what to do with your investments both now and in the future.

s & p index 5 year historical chart

When Will the Stock Market Crash?

I don’t know and neither does anyone else!

Paul B. Farrell of Marketwatch  writes:

“But when the Mack truck suddenly shifts into high gear … accelerating rapidly … finally catching all of us by surprise… none of this will matter … you’ll never hear it coming … till too late … few did in 1929, in spite of all the warnings … you didn’t hear in 2000 … nor in 2008 … nobody will in 2014 … the Mack truck will finally catch all by surprise, once again.”

A better question might be; “Is the overall stock market under, over, or fairly valued based upon historical metrics such as the price earnings ratio?”

Although not a perfect timing device (if it were, we’d all be genius investors), the PE ratio puts an approximate price tag on the market. Higher PE ratios suggest more overvalued and lower PE ratios suggest lower valuations. Even in an overvalued market, stock prices can continue to rise for a long time. Conversely, when PE ratios are low, it doesn’t mean they will rise immediately. To add to the confusion, there are various types of PE ratios, but that’s a topic for another article.

At present, the market PE ratio is hovering around 17. Contrast that with the historical PE ratio of 14-15. As you can see, the market isn’t excessively overvalued, but it is definitely not undervalued.

Stock Market Investing Caution

I’m sending this advice to my Wealth Tips Newsletter subscribers soon and wanted to share it with you as well.

Many investors got scared after the last recession and got out of the markets. And some of those same investors have been sitting on the sidelines during this big run up and are considering diving in now, after the big increase.

I don’t know if this describes you or not, but research has shown that investors tend to go with the crowd and get into markets at the top and sell at the bottom.

As the S & P index chart above shows, the overall stock market has been on a tear.As I previously mentioned, although the PE is not in the stratosphere as valuations were at the end of the 1990′s, the market is not undervalued.

In plain English, that means, if you invest money now, your future returns will likely be below the 9% average returns of the market.

You can avoid these mistakes by sticking with what I consider the absolute best investing strategy.

Curb your instincts to go all into the market’s now. 
 
My favorite investing approach is that of dollar cost averaging. It’s a systematic way to buy low and sell high. If you’re not already doing so, here’s how to get started, How to Buy Low and Sell High.
 
I’m not suggesting you get out of the markets.

I’m also not recommending that you avoid investing.
 
Think of this article as a yellow light suggesting you proceed with caution.
 
So, when will the stock markets crash? No one really knows, but it is a certainty that at some point there will be a stock market drop, when or how severe is unknown.

Should I reduce my equity exposure now? Only if you’ll be needing those funds within the next 10 years. If not, stick with your predetermined asset allocation.

How can I protect myself against a stock market crash? Be prepared, stay the course, and don’t panic.

Action Step

 
Be an educated investor. Avoid letting your emotions drive your investing direction.
 

    7 Comments

  1. I agree with continuous investing. I don’t care what the market is doing today or what it will do tomorrow. I am investing for the long-term and know that over the long-term, the market trends up. What looks high today could easily be a low in 5, 10 or 20 years. Sure this could be a high for the next 20 years or so, but again, history has shown that the market trends up over time. I’ll stick with that and just keep investing every month. It’s worked flawlessly for me through a major recession, 2 wars and the bursting of a bubble.

    Jon @ Money Smart Guides

    July 14, 2014

  2. Thank you for pointing out the important question Barbara! Valuation is the key. History proves that investing at high valuations produces below average rates of return, but investing when the valuations are low provides above average rates of return. The current PE ratio for the S&P 500 is now over 19. It’s MUCH higher for small caps, and the Shiller PE10 is now over 25.
    There will almost certainly be time periods ahead when much better bargains will be available. That will mean much higher rates of return and less risk for investors who are patient and have the capital to take advantage of those opportunities. Like you say, that doesn’t mean exit the market (I’m NOT advocating market timing). But it does mean the enterprising investor can be more careful today (raise some cash) and be ready to increase equity holding (not sell) when market valuations provide bargains.

    Ken Faulkenberry

    July 14, 2014

  3. Interesting post. If anyone is worried about crashing stockmarkets they could protect their portfolios with PUT Options or slowly reduce their exposure and go into other asset classes such as Bonds. It’s important to keep an eye on the market to smell the early signs of a crash.

  4. @Jon-I really appreciate the walk down the historical path. Unless you are over 75 (and then you certainly don’t want to be all in stocks), a long term perspective is helpful. I too have benefited from decades of monthly investing. THat said, I probably wouldn’t put a huge chunk in the markets today, for psychological reasons. Even though the markets aren’t terribly overvalued today, it’s likely that returns over the next few years will revert to their mean (suggesting lower than average returns for the next few years)

    BARBARA FRIEDBERG

    July 14, 2014

  5. @Ken, I wholly agree with your comments. During the last recession, when many were panicking and running for the exits, we took some extra cash and contributed to our investment portfolios at the bottom. Having the understanding of market history and that markets are cyclical, helps the investor avoid panic and exiting at the bottom or jumping in at the top.
    @Nick-Sophisticated investors (may want to look into buying Put options, the right to purchase a security at a predetermined price during a specific time period). Put’s are akin to insurance, you pay a price for protection you may or may not use. Personally, as a long term investor, I typically hesitate in paying the put premium (price).
    Nick, for those interested investor’s, I’d like to invite you to submit a guest article discussing the strategy of buying protective put options.

    BARBARA FRIEDBERG

    July 14, 2014

  6. I have not invested in the stock market because I am too concerned about it crashing. After watching my parents essentially lose their nest egg, I am overly cautious about where I invest my money.

    Michelle

    July 21, 2014

  7. Hi Michelle, It might be helpful if you learned a bit about the history of the stock market, the benefits and disadvantages. I suggest you check out “The Elements of Investing” from Ellis and Malkiel. It’s only 100 pages and an excellent introduction to investing.

    BARBARA FRIEDBERG

    July 22, 2014

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