How Investors Should Prepare for This Stock Market
The sell-off in stocks last week has been primarily written off as a much-needed correction and a buying opportunity. Furthermore, market gurus such as Jim Cramer are making claims that the market is going down because of chaos in China’s credit market, and that “shrewd” investors should take advantage of the weakness in shares of quality companies. Analyst Bob Doll told CNBC’s Patti Domm that stocks will correct 10 percent this year but that they will ultimately end the year higher. This seems to be more or less the “consensus viewpoint.”
But to me, these analysts seem to be overly complacent. The S&P 500 has had a tremendous run, nearly tripling from its 2009 trough to its 2013-2014 peak, and throughout this, there has been just one 20 percent correction. Historically, this is very unusual. The stock market is extremely volatile and corrections of 20 percent to 50 percent should be expected every few years.
I suspect that we are setting up for one such correction now. While it may begin slowly as there is still a “buy-the-dip” mentality, the fact remains that investors are overly optimistic, and they have consequently bid stocks up to historically high prices.
Right now, according to data provided by iShares for its S&P 500 Index Fund (NYSE:IVV), the S&P 500 trades at over 23-times earnings and at 4.6-times book value with a 1.8 percent dividend yield. While this valuation isn’t as extreme as it was before the 1929 crash and before the bear market at the turn of the 21st century, it suggests that stocks are much closer to a top than to a bottom. In fact there was a bear market — 1966 to 1982 — that peaked at approximately this valuation.