The Next Stock Market Crash Is Coming. Here's How To Prepare
Updated: Oct 27, 2021
Setting the Stage: The Delta Variant
2020 saw the second "once in a generation" economic crash for millennials. Following the opening act that was 2008, we got burned once again, but this time in a much more real way. While the COVID-19 pandemic did not take the lives of many millennials, it did strike loved ones in older age groups and directly affected everyone in an economic sense. The world came to a stand-still. Companies were forced to close, jobs were cut and people were sequestered in their homes in order to stop the spread of the virus. As we rolled into 2021, there was rising optimism that the quarantines would be fully lifted around the world, and life would get back to "normal" as vaccines began to roll-out from some of the world's largest pharmaceutical companies. However, 2021 seems to be headed towards an encore of 2020 now that we have the "Delta variant" of the disease, what experts are calling the "Goldilocks" variant of the disease: not too deadly or not too weak, but "just right" to spread rapidly. Thanks to the Delta, and newly discovered Delta+, version of the disease, we are seeing rapidly rising cases again, the likes of which we haven't seen since last winter. Couple this with a highly partisan vaccination campaign in the United States that is seeing low vaccination rates among Conservative strongholds across the Southern United States, and we are back over 100,000 new cases per day, back to November 2020 levels. Florida now accounts for 20% of the total new cases nationally, which is cause for concern due to the higher average age of the state thanks to the retired population.
The key difference in this Delta variant, however, is that it now seems to be affecting young people to the degree the original variant didn't. In Australia last week, an otherwise healthy 27-year-old and a similarly healthy 38-year-old passed away from the Delta variant, and we're seeing instances of this all over. People in their 20's and 30's are the age group with the highest rising percentage of ICU admittance, thanks to this new highly infection strain, with one key attribute across almost everyone admitted: they are unvaccinated.
The most important thing we can do to protect kids under 12 years of age, who are not yet eligible to be vaccinated themselves, is to ensure that as many people who are around them and who are interacting with them are vaccinated. - Dr. Nipunie Rajapakse, pediatric infectious diseases physician at Mayo Clinic Children's Center
The Effect On The Markets
Fear In The Markets: The Volatility Index
The stock market is a predictive tool, and one that relies on certainty and calm in order to succeed. Fear and doubt leads to increasing volatility in the markets as investors get spooked and pull money out of the markets in case they need a financial cushion. Over the years, people smarter than me have attempted to quantify this emotional element into something called "The Volatility Index" but colloquially referred to as "The Fear Index." Provided by the CBOE, the Volatility Index ($VIX) is a measure of investor fear in the markets by analyzing the put/call option ratios against the S&P 500 and charted just like any other index or stock. While that sounds like (and is!) a lot of complicated math, one mantra exists to boil it down: "When the VIX is high, it's time to buy. When the VIX is low, look out below." And right now, the VIX is very, very low. About 15% off its 52-week low, and down 36% year-to-date at time of writing.
Stock Valuations Are Out Of Control
Outside of the VIX, there are a few other ways to analyze the general health of the market. The first is to take a look at the price-to-earnings (PE) ratio of an index, like the S&P 500. The math essentially works out to the stock (or index) price divided by its earnings per share. If we look at the PE of the S&P at current levels, we see a ratio of about 45.7 based on the trailing 12 month performance. What does this mean? Well it's all about context. If you do this same calculation to the S&P 500 over the past 100 years, you get a ratio of 17. The last 50 years? The ratio ticks a bit higher to 20. So you'll see that a PE of 45.7 is a RIDICULOUSLY high number. Keep in mind, however, that 2020 saw dramatically depressed corporate earnings, throwing the number out of whack somewhat. So what other indicators could we take a look at?
How about The Buffett Indicator? Named for the famed Oracle of Omaha, Buffett uses this indicator to judge the relative valuation of the market measured against the American GDP. At current levels, the market is "significantly overvalued" according to math calculated by Gurufocus, indicating a potential return of -3% from this level.
The final way to look at the general health of the market is to pay attention to macroeconomic factors. There are two in particular worth looking at at present, with the first being the Delta variant described above. The mainstream media is beginning to chatter about the effects of the virus spreading as aggressively as it is again, even with vaccines in arms. This has led to speculative reports about potentially rolling back reopening plans in some states. New York has seen private-sector companies institute vaccine and mask mandates, and some are now controversially requiring proof of vaccination to enter. Los Angeles county is fully back in mask-mode, requiring masks anywhere you are indoors around others. Australia has gone back into a quarantine lock-down, similar to 2020, which could be a sign of things to come in the good old US of A.
The second macroeconomic factor to look at here is inflation. I'll cover this topic more in a post later this week, but inflation is at the top of many investors' minds at the moment. Groceries cost more, there are job gaps in essentially every industry, homes are getting more expensive to build and used cars might be the best investment you didn't make this year. However, there are competing viewpoints on inflation. Market experts see the recent 5.4% inflation mark in the latest economic report as something that's here to stay, fueled by the free money the government has been dropping from helicopters for the last 18 months. Others, like the Federal Reserve Chairman Jerome Powell, see this inflation as "transitory," fueled by several factors including: the current job gap causing a war for talent that includes rising wages, the aftermath of former-President Trump's trade war with China that caused the current chip shortage and the general lack of workers in jobs like shipping and transportation due to the soon-to-expire enhanced unemployment benefits. The fact that we have high-profile market experts clashing over this topic is spooking the market.
How Do You Prepare For The Impending Crash?
"Keep putting money in the market" might seem like weird advice, but stay with me for a minute. Take any date in the history of the stock market and fast forward 20 years. You will not be negative. You might be flat, or you might be up a little bit, but you won't be negative. That's the most important lesson you can learn in the markets: that time in the market is infinitely better than timing the market, because you never will. Don't let anyone, including me, tell you what the stock market is going to do in the near-term, because no one knows. That being said, here are some pretty good ways to prepare for a crash, if and when it comes:
There's a reason Warren Buffett recommends these bad boys. They are diversification in a can. They are automatic, and they are magical. Sure, you may not get 30% per year. But if you are getting 30% per year, shoot me the name of your broker so I can jump in. The indexes tend to average between 7-10% each year, inclusive of dividends. While that may not sound flashy, the power of compounding interest and a long-term time horizon essentially negate any downside of a stock market crash. Hell, you'll even get these indexes on sale if there is a crash.
Dividend Yielding Companies
Companies issue dividends for a few different reasons: they are solid in their cash position, and they want to offer shareholders added incentive to buy their stock. The solid cash position should be the reason you're purchasing a dividend company at any time, but especially in a stock market crash because you know that company will be well suited to weather the storm. And they don't have to be your parent's dividend yielders either, like Johnson and Johnson or Coca-Cola. Flashier companies, like Apple and Walt Disney, have SO much cash and they issue dividends. Again, just make sure you have a long-term outlook on the markets to truly take advantage.
This one sucks, but hey, it's safe! Bonds issue coupons, which is basically the fixed-income equivalent of a dividend. They don't fluctuate much, and at maturation, you'll have the principal plus interest on the coupons. Just don't come crying to me when you aren't a millionaire through your 30 year T-bills.
Gold is having a weird go of it recently. The long-term undisputed champion of the "store of value" category, it's seen its value fluctuate pretty wildly in the last 18 months as the pandemic got us closer than ever to some sort of Mad Max-type future where everyone tapes pots and pans to themselves and trades in gold bars...? You can have physical gold in your home under the mattress, or you could go the Ray Dalio route and purchase mutual funds centered around purchasing gold, like $GLD. However, the whole "king of the store of value" argument has taken a serious dent thanks to....
This is not, I repeat *IS NOT*, where you email me to tell me that Dogecoin is the infinitely better cryptocurrency. Bitcoin is king of the cryptocurrency landscape in terms of market capitalization, and I will absolutely come back and change this when Cardano or whatever the hell overtakes it. Until then, it's Bitcoin's time. In the last 10 years, Bitcoin has appreciated over 460,000%, creating billionaires like the previously-shafted Winklevoss twins of Facebook fame. It also looks like it's still in it's nascent stages, with more and more millionaires open to owning crypto and institutions now granting exposure to their premium clients. Keep in mind, though, that you should not take out a second mortgage on your home and dump it into Bitcoin. It could go away tomorrow, so be prudent in your investments here.
This one is obviously still very safe, but has aggressive upsides and downsides. Buffett's adage of "you always want to have enough cash around, but not too much" still rings true. Cash is essentially a tool, at the end of the day. You trade it for goods and services. You leverage it into assets. If you don't have any, you live out a bus shelter or an upturned shopping cart, so probably keep some around. But if you keep too much of it around, it will literally decay in a savings or checking account, being outraced by inflation. And whatever you do, for the love of all that is holy please do not open a CD.
So What Do I Do?
If you learn nothing else from this article, learn this: you must approach the purchasing of assets from a long-term perspective in order to be truly successful. Sure, you hear about short-term or day-traders making millions of dollars and retiring at 35, but that's the exception, rather than the rule. In truth, no one knows exactly what the market is going to do on a short term basis. Even the most successful hedge fund manager of all time, Jim Simons, who won an award for advancements in mathematics and generated returns north of 40% every year, only won on a little over 50% of his trades. The best thing you can do to prepare for a crash is...well...prepare! Assess your financial situation, make sure you have enough cash on hand and then buy what is appropriate for your situation. And if you get a stock or two on sale, more power to you. Happy shopping!
When do you think the next crash is coming? What are you doing to prepare? Let me know in the comments below! And don't forget to sign up for my email list so you can get these in your inbox as soon as they post. Thanks for reading!