Get Ready for the 2015 Market Crash
Over the past five years, we've enjoyed one of the longest, and most generous, bull markets in history.
But all good things must come to an end.
No bull market lasts forever, and this one has about run its course.
You don't have to take my word for it.
There's plenty of historical precedent to make the case for me...
You see, since 1928, the average duration of a bull market is 57 months. This one is now 71 months running. It's also returned 190%, compared to the average 165%.
Valuations have gotten so high that financial consultant Andrew Smithers believes we're in the third-biggest stock bubble in history.
Looking at key long-term measures, Smithers says U.S. stocks are now about 80% overvalued. And since 1802 (when data was first tracked), there have been only five times when stocks have been more than 50% overvalued: 1853, 1906, 1929, 1969, and 1999.
Each one of those years marked the peak of a massive, once-in-a-generation stock-market bubble. And only two of those bubbles (1929 and 1999) were bigger than today's.
Of course, historical precedent isn't the only headwind this market faces. Looking forward, anyone can see things are getting bad.
Global Economy Stalling
The engines of the global economy are stalling, one by one.
Mature economies, like Europe and Japan, are hardly growing at all.
Eurozone growth came in at 0.9% last year, and the OECD forecasts just 1.1% growth in 2015. Low inflation is a concern, as well, with prices expected to edge up just 0.6% this year. Worse, some countries in Europe have already seen deflation, forcing the ECB to rush to the rescue with stimulus efforts.
Things are even worse in Russia, which is lumbering under the weight of Western sanctions and cratering oil prices.
Russia's currency is at an all-time low vs. the dollar, and the country's own finance minister expects a 3% economic contraction in 2015. Other analysts are predicting far worse.
Japan continues to languish in its decades-long malaise. And in China, the days of 10% and 11% growth are but a memory.
The country's economy expanded just 7.4% last year, its slowest pace since 1989. And it's expected to slow even further this year.
And without China's sprawling manufacturing base, commodities-driven economies from Brazil to South Africa have lost the key export market that supported their growth for so long.
And the United States?
Well, we're doing better than most, but that's not saying much.
Damned If You Do...
The U.S. economy grew just 2.2% last year, and will see only a 2.9% expansion in 2015.
Going forward, the United States can pursue one of two paths...
If growth remains resilient, the Federal Reserve will continue to rein in monetary policy and follow through with a rate hike.
The other possibility is that the U.S. economy succombs to weak global growth, and tumbles back into a recession itself.
Either way, stocks go down.
A severe correction is inevitable, and as I said earlier, long overdue.
Analysts can dress it up however they want but the truth of the matter is that every bull market in history can be broken into just three phases:
- The Accumulation Phase: This is the period at the end of a downtrend when informed investors — hedge funds, money managers, politicians, etc. — start snatching up shares on the cheap.
- The Public Participation Phase: As the market bottoms and begins its rebound, public fear and apprehension towards investing subsides, and retail investors retest the waters.
- The Excess Phase: Finally, momentum picks up and exuberance takes over. When that happens, a bear market is born, as the informed investors from Phase 1 bail out and leave retail investors holding the bag.
We're in Phase 3 right now.
You saw what happened when the Dow plunged 1,100 points from September 19 to October 16. It was a blood bath.
Well guess what: Those weren't retail investors dumping their holdings, that was Wall Street.
And it's just the beginning.
Since that modest correction, stocks have bounced back, soaring to yet another record high.
That's totally unreasonable, and unsustainable, given the state of the global economy and the likelihood of a rate hike this year.
Even Federal Reserve Chairman Janet Yellen is calling it a bubble.
“Valuation metrics in some sectors do appear substantially stretched,” she said. “Moreover, implied volatility for the overall S&P 500 index, as calculated from option prices, has declined in recent months to low levels last recorded in the mid-1990s and mid-2000s.”
Translation: Stock prices are too high, and investors are too complacent.
Admitedly, that's a bit ironic considering it was the the Federal Reserve that opened Pandora's box by plying the markets with limitless, virtually free capital. But she's right. It's the end of the line.
The question is, then, what to do about it...
When All Else Fails...
One option is to buy gold.
There's always a flight to safety when things go south, and precious metals benefit. If you don't own gold — either physically or through an ETF — now is a good time to buy some.
Gold prices have withered over the past year, mostly because investors — large and small — pulled their money out of precious metals and put it in stocks to chase the bull market.
That's a decision they'll come to regret if they don't take the proper precautions now. Soon, the trend will reverse. Stocks will plunge and everyone who's caught off guard will suddenly storm back into gold.
Another thing you might consider is adding an inverse ETF to your portfolio.
There are plenty to choose from:
- Rydex Inverse S&P 500 Strategy Fund (RYURX): One of the more traditional bear funds, RYURX delivers a return opposite to what the S&P 500 does. So if the S&P 500 goes down 5%, it goes up 5%.
- ProShares UltraShort S&P 500 (SDS): This fund is leveraged to give you twice the return of any drop in the S&P 500. For example, if the S&P 500 loses 5%, this fund goes up 10%. Be warned though, if the market goes up 5% this fund goes down 10%.
- ProShares UltraShort Russell 2000 (SRTY): This is a more aggressive play. Small caps are more vulnerable to sell-offs, and this fund targets the sector by delivering a return that is three times larger than any decline in the Russell 2000 index.
Again, the thing to remember about these funds is that they'll lose value so long as the market keeps going up. But the potential rewards can be great if the market suffers a setback.
Used appropriately, even a small allocation of your capital could more than make up for any losses you sustain in a market crash.