Examining Stock Market Risk Right Now

While many Americans struggle with the challenges of rising inflation – at the grocery store, at the gas pump, rising rent and more, stock market investors are a complacent bunch right now.

The U.S. stock market is indeed enjoying double-digit gains in 2021, propelled higher by government spending that flooded the economy during the Covid crisis and the Fed’s rock-bottom interest rates.

Can this continue?

There is an old market adage: the stock market takes the stairs up and the elevator down.

That adage reminds us that while stock market gains tend to be slow and steady, stock market crashes tend to be violent, fast and usually quite unexpected.

There are three major risks right now hovering beneath the rosy stock market performance figures this year, which are worth examining. These include: 1) valuation levels 2) margin debt and 3) interest rate shock. Today, we’ll explore valuation levels.

You’ve probably heard that the stock market is “overvalued” by many measures.

Experts like to examine longer-term measures like the Shiller P/E or price-to-earnings ratio, which looks at average earnings over the past 10 years, as a particularly useful metric to determine stock market risk.

Stock market valuations continue to increase. In September, the Shiller CAPE ratio hit 38.34, which marked the fourth month in a row with higher valuations and the highest level since late 2000 (just before the Dot-com bubble burst in 2001).

You may recall, in the late 1990’s, internet stocks skyrocketed – the Dot-com boom, they called it. Many companies had zero earnings, yet speculators drove technology stocks higher and higher betting that someday these Dot-com firms would turn a profit.

The primary cause of the 2001 stock market crash? Overvalued stocks.

It was a painful stock market crash. The NASDAQ stock index lost a stunning 75% of its value from 2000-2002.

That means if you had $100,000 invested in the NASDAQ at the beginning of 2000, your account value fell to $25,000 just two years later.

Then, it took a very long 15 years for the Nasdaq Index to reclaim its 2001 peak. So, that means you would have had to wait 15 years for your account balance to return to the $100,000 level.

How would you feel if your stock portfolio fell even 50% right now and – then took 15 years to get back to break-even?

Let’s shift gears and look at how gold performed during that 15-year period from 2000 to 2015.

Gold climbed 554% from its 2000 low at $276 an ounce to its 2011 high above $1,800 an ounce, before entering a minor correction period and slipping to $1,226 – which registered an overall 344% return for that 15-year period.

The Bottom Line

Stock market crashes can be frightening and even traumatic experiences for investors.

It is another reminder why diversification is so important. Diversification into gold is a proven portfolio diversifier. Holding a position in gold reduces your total account drawdown level during stock market crashes, as gold tends to climb when equities fall. Learn more here.

Check back soon for another analysis of stock market margin debt risks – and why that is worth paying attention to.

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