Investors seem to have recovered from Black Monday. Unfortunately, optimism about the stock market may be a little premature. In fact, I think the stock market is poised for a serious correction. One that makes Black Monday seem like a Sunday afternoon church picnic in July. While most investors fear a major correction, there are ways you can fight back and survive the next stock market crash.
Overvalued Market Points to Stock Market Crash
The most hated bull market in history may be alive, but it isn’t exactly kicking. And investors are skittish about what the next few months hold. And they have good reason to be.
The stock market is seriously overvalued and being propped up by anxious investors looking for any reason to keep the good times rolling. The global economy is doing terribly. The Federal Reserve is thinking of dousing the fire that ignited the bull market by raising interest rates. And U.S. stocks are doing terribly.
After years of growth, the broader stock market is beginning to feel the weight of overvaluation. The S&P 500 might be up 200% since the markets bottomed in March 2009, but it’s down three percent so far this year. It’s a good start.
For starters, equities are seriously overvalued. According to the Case Shiller CAPE PE Ratio, the S&P 500 is overvalued by around 67%. The ratio is at 25.10; the average since 1881 has been 17. The only other times it has been higher were in 1929, 2000, and 2007.
The Market Cap to GDP Ratio is at 116.4. A reading of 100 suggests the markets are fairly valued. The higher the ratio is over 100 the more overvalued the stock market. It has only been higher than the current reading once since 1950; that was in 1999.
And the future looks bleak.
Earnings Growth Nowhere to be Found
Stock markets are only as strong as the equities that go into making them up. For years, the bull market was fuelled by the Federal Reserve and its ultra-low interest rate environment. But the sugar mama train is coming to an end and so too is the bull market.
When rates do rise, investors will have to actually take a look at valuations. No more blindly buying on the dips selling on news. Speaking of news, the third quarter looks miserable for U.S. stocks.
Companies have lowered the bar for earnings in the third quarter. Earnings growth for the third quarter of 2015 is estimated to decline 4.4%. That’s much higher than the forecasted decline of just one percent at the start of the third quarter. If expectations become reality, this will mark the first back-to-back quarter of earnings declines since 2009. (Source: Factset.com, September 17, 2015.)
Nine sectors (out of 10) have lowered their growth rates due to downward revisions to earnings; led by the Materials sector. Of the 107 companies that have issued guidance for the third quarter, 76 (71%) have issued negative EPS guidance while 31 companies have issued positive EPS guidance.
As for revenues, third-quarter sales are projected to fall 2.9%. This is also higher than the estimated year-over-year revenue decline of 2.5% at the beginning of the quarter. If this comes to fruition, it will mark the first time the index has seen three consecutive quarters of year-over-year revenue declines since the first quarter of 2009 through the third quarter of 2009.
Despite being markedly off (to the downside) with their projections, analysts expect earnings growth to come back to life in the fourth quarter of 2015 and revenue growth to return in 2016. If history is any predictor, optimistic analysts will be wrong again.
Top Tips for Surviving a Stock Market Crash
The best way to approach a stock market crash is to go against everything your body and mind tells you to do. If you’re a perma-bull, you might want to play dead. That could mean diversifying your portfolio with a larger portion designated to money market securities such as CDs (certificates of deposit), U.S. Treasury bills, or other high-liquidity short-maturity financial products.
If however, you are a contrarian who has waited for the markets to crash, you may want to follow the advice of Baron Rothschild, that wily 18th century British Nobleman (and member of the Rothschild banking family), and buy when there’s blood in the streets.
If you think a crash is imminent, it might be better to take an initial proactive stance. For many investors, that will mean putting a portion of your retirement portfolio into precious metals like silver, gold, and platinum.
In times of economic uncertainty, investors turn to inflation hedges like silver and gold. Precious metals will gold their value as stock prices swing wildly. And the fiat currencies that support them become worthless. You can’t eat gold or silver but you can liquidate it. Investors won’t be able to say that with useless paper stocks or money.
Consumer Discretionary Stocks
How do we know Wall Street is out to lunch? Despite growing personal debt levels, stagnant wages, and inflation, and despite the fact that in the third quarter of this year earnings are projected to slide 4.4% and revenue is forecast to fall 2.9%, the Consumer Discretionary sector is predicted to report the largest earnings growth of all ten sectors. It doesn’t add up.
What does make sense when the stock market crashes is to consider consumer staples. Why? Because people need consumer staples to survive. We will give up going to restaurants, casinos, movies, and buying cars to save money. But we won’t give up groceries, toilet paper, shaving crème, or toothpaste. And frankly, in times of emotional need, people won’t give up cigarettes or alcohol either.
You may not be able to control economic cycles, but you can adjust your investing strategies. And it’s important to have a plan in place for the crash of the stock market. Because it will happen. That’s the way the markets work. They rise and fall. They ebb and flow. And with the right strategies, you can make money in any market.