The U.S. stock market continues its historic run with no signs of slowing down. Since March of 2009 the Dow Jones Industrial Average has soared 262%. As the market ticks higher, investors are looking for the top so they can sell their stock holdings before the market crashes.
Timing the stock market is futile because no one knows when the market will fall nor, do they know what will drive it lower but here are a few culprits that may bring the stock market down.
- Rising interest rates. A rise in interest rates will eventually become a threat to stock prices. If investors can receive a 6% to 7% risk free rate of return, then money will leave stocks and move to bonds. We’re a long way from bonds yielding 6% or more. The current U.S. Ten Year Treasury Note is yielding 2.4% and the historical rate has been 4%.
- Inflation. Inflation and interest rates are linked and the two will rise together. Inflation is the increase in prices for goods and services meaning a dollar today with be worth less tomorrow. The U.S. postage stamp is a great example of price inflation. In 1974 the price of a postage stamp was $.10 and today stamps costs $.49, an average annual increase of 3.74%. Over the past 12 months, the Consumer Price Index has increased 2.24% and the Gross Domestic Product has risen 2.3%.
- Valuation. The current price to earnings ratio for the Dow Jones Industrial average is 20.4 and the Shiller CAPE ratio is 31.51. The CAPE ratio is a cyclically adjusted PE ratio and it’s based on the inflation adjusted earnings from the previous 10 years. The peak for the ratio was 44.19 in December of 1999. The lowest level for the CAPE was in 1920 at 4.74. In 1929 it peaked at 30.
- Washington D.C. A failure for our government to pass a tax bill will be problematic. In addition to the tax bill, the government is working on a new health care bill and an infrastructure spending package. The government needs to pass these items for the market to continue rising.
- North Korea. If North Korea launches a missile and it lands in a populated area, the stock market will sell off.
- Bitcoin. Bitcoin by itself is not a threat to the market but the behavior to buy Bitcoin may be a problem. As speculators chase the price of Bitcoin they sell stocks and other assets to fund their purchases. If the price of Bitcoin corrects, this may bring down the price of the other assets.
- Debt. The public debt as a percentage of GDP is currently 103%. By comparison, the debt level in 2007 was 62%. A high debt level protrudes trouble because it eventually must be paid off and investors may sell assets to cover these debt payments.
- Failed Merger. In 1989 the failed acquisition of United Airlines sent the Dow Jones down by 190 points, the largest drop since the 1987 correction. There are a few high-profile mergers in the works and the failure to get these done could send the market down.
- Time. The current bull-market is 8 ½ years old. The average bull market typically lasts about 3 to 5 years. However, bull markets rarely die of old age.
- Other. The next bear market will be triggered by some other event as no two corrections are the same. The next correction will come out of left field and catch investors off guard. Hindsight and a 20/20 review will seem obvious to those who study market corrections but we won’t know about it until after the fact.
It’s extremely difficult to try and time the market and sell before a correction arrives. Market timing works both ways. If you’re lucky enough to sell your stocks before a fall, when do you decide to buy back into the market? Buying stocks at a market bottom is much harder than selling stocks at a market top.
An investor who purchased an S&P 500 index fund in October of 2007 endured a drop of 41.5% in 2008, however, if they held on through last month they would’ve more than doubled their money. The average annual return for the S&P 500 since October of 2007 has been 7.35%.
If you’re concerned about a stock market correction, my recommendation is to diversify your holdings across cash, bonds, small stocks, large stocks, international stocks, real estate, and other asset classes.
There is a time for everything, and a season for every activity under the heavens… ~ Ecclesiastes 3:1
Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm. For more information please visit www.parrottwealth.com.
November 11, 2017
Note: Past performance is not a guarantee of future returns. Your returns may be more or less than those posted in this blog.
 http://articles.latimes.com/1989-10-15/news/mn-225_1_stock-market, 10/15/1989, Associated Press.