Stocks on the Precipice

September 2016

It has been a while since I’ve written on the stock market (see Market Comments Archive).  But when I did, I made some good calls:

  • In 2006 – 2008, I was screaming that stocks and real estate were overvalued: see Who Cares About P/E Ratios (Oct 2006), The State of Housing (Feb 2007), Why Home Prices Will Continue to Fall (Feb 2008)The Bleak Outlook for the US Stock Market (March 2008).  Sure enough, they headed for a crash.
  • At the same time, I was bullish on gold and encouraging folks to buy: see Go for Gold (October 2006),  The Case for Buying Gold (April 2008).  Sure enough, they continued their bull market and had a few years of great returns.
  • In early 2009, near the stock market bottom, I got more constructive on stocks and recommended buying some in a mixed stock market strategy.  I remained cautious about overall valuations, so recommended buying some but not going all in: see A Mixed Stock Market Strategy (March 2009).  Sure enough, despite the underlying overvaluation, stocks took off on another 7 year bull market run.
  • In 2010, my wife and I decided to buy our first home in San Diego, hoping that most of the real estate decline had already taken place and that it was time to make an investment in housing.  It turned out, in retrospect, to have been just a year shy of the real estate bottom.  Home prices have shown strong growth in Southern California ever since and it has been one of our best investments to date.
  • In the early 2010s, I turned quite bullish on U.S. real estate and encouraged my wife and I to convert our San Diego home into a rental property and to buy another primary residence in Boston.  Sure enough, home prices continue to march upward across the country.
  • Over the last 2-3 years, I’ve been very cautious on U.S. stocks, not putting any money into them (besides retirement accounts), because I’ve been worried about overvaluation and long-run returns (see John Hussman’s The Iron Laws of Valuation and Speculation (2015))  While stocks have continued to creep up, I think they are near the end of this bull leg and poised for a significant decline.

So my track record is good, strong enough to be taken seriously.  And, sitting here today, I see stocks on the edge of a precipice.  This bull market has been quite long in the tooth, greater than 7 years from the lows in March 2009.  Valuations are as high as they have ever been in the last 100 years (aside from 2000 and 1929):

Even if you think stocks will continue going up, there is very little room for upside right now.  Then, two recent events have me concerned in terms of timing of a decline:

  1. S&P Earnings.  According to the long-term data (graciously organized and available by Nobel Prize winning economist Robert Shiller), S&P earnings may be starting to turn to the downside.  With threat of higher interest rates, slowing buy backs, and mean reversion from record-high profit margins, it would be unsurprising if earnings take a bit of a down cycle.  This means that an already-overvalued stock market will soon seem even more outrageously overvalued.  As I wrote in 2007, this creates a “Double-Whammy to the Downside for Stocks” (see The Bleak Outlook for the US Stock Market (March 2008)):sp_earnings-201609
  2. Market Action. Market action, which was positive over the last few years despite an overvalued market, has started to deteriorate.  After 5 straight years of consistent growth and returns, the last 2 years have started to stall, and recently have started to turn for the worse.  My two favorite stock market traders, David Skarica (Addicted to Profits) and Mike Swanson (Wall Street Window), have both recently turned from somewhat bearish to very bearish over the last few months.  For example:

Bottom line:  Stocks have been overvalued for quite some time now, and recent events have suggested they may be starting to turn for the worse.  There is always uncertainty with the timing, of course, but the risk-reward of stocks right now just isn’t there.  My stock market exposure is very low right now, and I suggest you think about lightening yours as well.  Good luck!

— Thriving Dad

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