http://finance.yahoo.com/news/stock-market-crash-50-not-164715082.html
So here goes:
By many, many historically predictive valuation meassures, stocks are overvalued to the tune of 75%-100%.
In the past, when stocks have been this overvalued, they have often "corrected" by crashing (1929, 1987, 2000, 2007, for example) . They have also sometimes corrected by moving sideways and down for a long, long time (1901-1920, 1966-1982, for example).
After long eras of over-valuation, like the period we have been in since the late 1990s (with the notable exceptions of the lows after the 2000 and 2007 crashes), stocks have also often transitioned into an era of undervaluation, often one that lasts for a decade or more.
In short, stocks are so expensive on historically predictive measures that the annual returns over the next decade are likely to net out to about 0% per year.
How we get there is anyone's guess.
But...
A stock-market crash of ~50% from the peak would not be a surprise. It would also not be the "worst-case scenario," by any means. The "worst-case scenario," which has actually been a common scenario over history, is that stocks would drop by, say 75% peak to trough.
Those are the facts.
Why isn't anyone talking about those facts?
Three reasons:
- First, as mentioned, no one in the financial community likes to hear bad news or to be the bearer of bad news when it comes to stock prices. It's bad for business.
- Second, valuation is nearly useless as a market-timing indicator.
- Third, yes, there is a (probably small) chance that it's "different this time," and all the historically predictive valuation measures are out-dated and no longer predictive.
The third reason is the one that everyone who is bullish about stocks these days is implicitly or explicitly relying on: "It's different this time."
Just so you know, every time there is a long bull market like the one we've had, people come up with lots of reasons to explain why it's different this time. (And understandably so! Everyone wants the bull market to continue, and no one wants to miss further gains.) They did that in the late 1920s. They did that in the late 1990s. They did that in 2007. Usually, however, it isn't different this time, and normality reasserts itself with a vengeance.
As for timing... Unfortunately, even if historical valuation measures are still valid, and stocks are poised to have another lousy decade, today's valuations won't help you predict what the market will do over the next year or two.
And it's almost as painful to miss further market gains by turning cautious too early than it is to get obliterated in a crash. (Almost.)
So that's why almost everyone's still bullish.
But what today's valuations do tell us is that no one should be surprised if stocks crash 50% or more or are still trading around the current level in a decade.
Now you know!
(None of this means that you should sell your stocks, by the way. I own stocks, and I'm not selling. It just means that you should be mentally and financially prepared for a major drawdown. You should also be diversified.)
Here are some of the valuation details...
Stocks are wildly overvalued on historically predictive measures
According to several historically valid measures, stocks are now more expensive than they have been at any time in the past 130 years, with the exception of 1929 and 2000 (and we know what happened in those years).
For example, the chart below is from Yale professor Robert Shiller. It shows the cyclically adjusted price-earnings ratio of the S&P 500 for the past 130 years.
As you can see, the current PE ratio of at least 26 is miles above the long-term average of 15. In fact, it is higher than at any point in the 20th century, with the exception of the months that preceded the two biggest stock-market crashes.
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