Is the Next Market Crash Imminent?

Is the Next Market Crash Imminent?

Robert Isbitts of Sungarden Investment Research is sounding alarm bells regarding the following numerical coincidence he discovered:

  • From September 1, 1995 until the peak of the tech-bubble on August 18, 2000, the S&P 500 return (excluding dividends) was 165%.
  • From March 6, 2009 (the Great Recession bottom) through February 26, 2014 (around now), the return was an almost identical 164%.

What’s significant about this? Two identical market returns over two identical periods of time (1,813 days or just under five years), and the first was followed by multiple years of negative stock returns. Isbitts further points out that the market rally in between these two high-growth periods (from October 11, 2002 until the October 12, 2007 peak) generated a lower 95% return but lasted almost exactly the same period of time in days (1,827) before collapsing. He additionally warns that today looks and smells a lot like the year 2000, the peak before the first crash.

Armed with these facts, what should an investor do? Basically, you have three choices:

  • Ignore them.
  • Sell everything (or at least all your U.S. stocks) now.
  • Sell some of your stocks just in case and try to figure out when would be a good time to buy them back.

To me the right answer is obvious. If you are following an investment strategy that’s based on both growing your savings enough to support all your future goals while trying to manage the risk, then choice one is the right one for you. Your focus should be on an appropriate diversification model and on the selection of investments (I prefer mutual funds and ETFs) that have been shown via research to outperform with persistence over time or to minimize the volatility of returns in their respective asset classes. Market movements have nothing to do with such a strategy so you’d do best not to pay attention to them. This is not to say that you should simply buy and hold your investments. Rebalancing them periodically is necessary to ensure your asset allocations remain supportive of your growth goals and of your risk mitigation objectives. Adjustments to the investment strategy may also be needed due to life changes that occur. You can also look at market dips as buying opportunities, or even consider periodically increasing or decreasing the weightings in asset classes which you believe to have become undervalued or overvalued, although timing that can be problematic since such trends can last for many years.

Choices 2 and 3 both involve market timing, which I frankly do not believe anyone can do consistently. It requires not only knowing what information will drive markets up or down but also the ability to act on that information before anyone else does. And if you choose to get out of the market because you fear a drop is imminent, your will be faced with the additional question of when to get back in. Those are two very hard decisions to time correctly.

I agree with Isbitts insofar as he warns investors not to become complacent in today’s stock market, by many measures highly-valued historically. It’s common nature during rallies for us to focus more on the opportunity for gains. But as stock prices continue to rise, the risk of losses (or at least the risk of future underperformance) becomes greater. These are the times when we should become more cautious with our investments, not adding to the risk by striving for increasing yields, as many investors seem to be doing right now.

In case you’re wondering what happened after the market peaked in 2000, these were the total returns for the subsequent decade:

  • One year: -21%
  • Three years: -33%
  • Five years: -18%
  • Ten years: -27%

If you’re in the stock market for the right reason (growing your savings for a purpose in a disciplined, risk-managed way), don’t get distracted by threats of looming market crashes. You may lose a little money in the short-term, but over time you will do fine.

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