How to Protect your 401(k) from a Coming Stock Market Crash

170215_PC_whitefootThe idea of an impending stock market crash may seem pretty untenable right now. After all, compared to the rest of the world, the United States had the most encouraging economic, business, and financial outlook in 2014, and the same goes for 2015. But there are several key factors painting a not-so-rosy picture for the global economy and your retirement could be on the line if you’re not cautious. (More on how to protect your 401(k) from the coming stock market crash in a bit…)

U.S. Economy Not as Strong as It May Appear

On the surface, nearly every major U.S. economic indicator was positive at the end of 2014. On December 23, the U.S. Department of Commerce announced that third-quarter gross domestic product (GDP) soared five percent—the strongest quarter of growth since 2003.(1) This robust third-quarter growth comes on the heels of a strong 4.6% advance during the second quarter.(2)

And in late January, the Department of Commerce announced that real GDP for 2014 was up 2.4% year-over-year. (3) That might sound encouraging, but keep in mind that despite everything the Federal Reserve has done (QE1, QE2, and QE3), the American economy continues to perform at about 30% below its historical norm.

Between 1930 and 2014, the average annual increase in U.S. GDP was 3.38%. And we are way below those levels. In fact, the 2.4% increase in 2014 is below the 2.53% increase in 2010, when investors widely believed the market was still struggling.

The stock market may be trending near record-highs, but that has more to do with the Federal Reserve’s easy monetary policies and artificially low interest rates than it does a rock solid U.S. economy. The fact of the matter is that the U.S. consumer is tapped out.

U.S. underemployment remains stubbornly high; so does personal debt. U.S. wages are stagnant, and more and more Americans are on food stamps. According to the latest available figures, as of October 2014, more than 46.67 million Americans (15% of the population), or 22.86 million households, receive food stamps. Since the so-called U.S. economic “rebound” in 2009, food stamp usage has increased more than 24% from 37.6 million Americans.(4)

And Wall Street is starting to feel the effects. During the fourth quarter, the average revenue growth for S&P 500 companies was just 1.4%.(5) On top of that, December household purchases fell 0.3%—the biggest monthly decline since September 2009.(6) Kim and Kanye may be doing well, but most Americans are not.

Global Economy in Dire Straits

Incredibly, the U.S. economy is the one economic “bright spot.” In 2015, the U.S. economy is projected to rise 3.6%; up from previous forecasts of 3.1%. The rest of the world, however, isn’t faring so well.(7)

The U.S. doesn’t exist on an isolated island. Roughly half of all S&P 500 companies derive revenue from outside the U.S. A strong U.S. economy is great, but a strong dollar impacts imports, exports, corporate revenues, and earnings.

In 2015, the global economy is expected to grow 3.5%, down from the October 2014 estimates of 3.8%. Growth in the eurozone, the world’s largest economic region, was cut from a paltry 1.3% to an anemic 1.2%. In 2016, the eurozone is projected to grow just 1.4%, down from the previous 1.7% growth projections.

Japan will be eking out growth of just 0.6% this year and 0.8% in 2016. And thanks to plunging oil prices, Russia is headed for a recession. In 2015, the Russian economy will contract by 0.3%, seeing further contraction of one percent in 2016.

The two biggest emerging markets are also stalling. China’s growth forecast has been cut to 6.8% in 2015 (from 7.1%) and 6.3% in 2016 (from 6.8%). India’s growth has also been cut to 6.3% in 2015 and 6.5% in 2016.

Then there is a raft of global issues that could derail the six-year bull market. Greece is a mess and could leave the eurozone; Argentina defaulted on its sovereign debt for the second time in 13 years; and Venezuela is getting hammered under low oil prices. Lest we forget about the geopolitical tensions in the Middle East.

The idea of a global stock market crash is not all that much of a stretch.

Three Warning Signs of a Stock Market Crash

If the aforementioned data weren’t enough, below are three additional warning signs that the stock market could very well be headed for a crash…

VIX (Fear) Index

The VIX hit an all-time high in late 2008, just before the markets collapsed. Since then, three rounds of quantitative easing, ultra-low interest rates, and stocks at record-highs have lulled investors into a false sense of security. The S&P 500 has not experienced a 10% decline since 2011. The worst decline last year was 7.5%; it was short lived.

But with rising interest rates expected to hit the U.S. in mid-2015, the cost of capital will increase, making it more difficult for businesses to carry their debt load. The VIX, also known as the “fear index” that measures volatility, is hovering around 15.0, marginally above the 2014 average of 14.5.

Current Bull Market the Fourth Longest in History

The current U.S. bull market, which began in March 2009, is roughly 2,180 days old, which makes it the fourth longest bull market since 1928. To put the current bull market into context, the average S&P 500 bull market lasts just 933 days. The longest bull market ran from December 1987 to March 2000.

Since bottoming at 666 on March 9, 2009, the S&P 500 has soared more than 210%, breaking through the 2,000 mark for the first time in August 2014 and now closing in on 2,100. Previous bull markets may have been fuelled by underlying fundamentals and earnings growth, but this time, it’s different.

Overvalued U.S. Stock Market

The Shiller PE 10 is a cyclically adjusted price-earnings ratio (CAPE) based on average inflation-adjusted earnings for the S&P 500 from the previous 10 years. The Shiller CAPE is currently sitting at 27.49; that’s 65% above the historic average of 16.60. On only three other occasions since 1882 has it been higher: 1929, 2000, and 2007.(8)

How to Protect your Retirement Nest Egg from a Stock Market Crash

For most Americans, their 401(k) is the lifeblood of their retirement. Sponsored by an employer, it lets employees save and invest a portion of their pay before taxes are taken out. Taxes are paid when the money is withdrawn from the account.

The joy of a 401(k) is that you control how and where your money is invested, with most being invested in mutual funds made up of stocks, bonds, and money market investments. Typically, the older you get, the more conservative (low-risk, low-growth) your 401(k) investing approach should be.

How can you protect your 401(k) from a stock market crash? Fortunately, even in the worst-case scenario, should the company you work for go under, your 401(k) is safe—or at least the money you invested into it is.

If you believe the stock markets are headed for a crash, there are a number of different financial instruments you can transfer into without penalty, instruments that will not evaporate like stocks in the event of a crash. They are as follows:

  • Annuities from insurance companies
  • Cash in the form of money market funds (interest is virtually zero, but they are a safe haven and more attractive than falling stocks)
  • Real estate funds (examples include REITS like APTS, ORC, and EARN)
  • Short-term maturity bond funds (such as ETFs like TIPS and MINT)

Bull markets don’t last forever. If you’re approaching retirement and want to reduce your risk, re-evaluate your portfolio and adjust it so that it meets your long-term lifestyle and financial needs.