The figure investors should all be paying attention to is the Shiller price-to-earnings ratio for the S&P 500. As of February 3, the Shiller price-to-earnings for the S&P 500 has reached unprecedented highs. The ratio was around 35, which is more than double the long-term average. To give you some perspective regarding this figure, there have only been five periods in history where the Shiller price-to-earnings ratio went above 30 and stayed there amid a bull market run. Amongst them, two events happened within the past three years, and led to declines of 20% and 34%, respectively, in the S&P 500. Simply put, anytime the Shiller price-to-earnings ratio surpasses and sustains 30 in a bull market rally, it has eventually suffered in a minimum correction of 20%.
The truth is that even if stock prices fell by half, the Shiller price-to-earnings for the S&P 500 would still be above the long-term average. Therefore, if the market only drops by 20 percent this year, that would be the best-case scenario and we should consider ourselves to be extremely lucky. Especially because stretched valuations are just one of the concerns at the moment. Nosebleed premiums baked into the stock market assume that the health crisis will soon disappear, but according to a recent survey that reported that roughly half of the population is unwilling to get in line for a vaccine, and this outlines that the outbreak might be far from over.
Additionally, our economy is still hurting. Millions upon millions of workers have been laid off or furloughed, and many of those who are still working have seen their hours cut. A significant number of Americans and their families are still counting on continued assistance from the federal government to make it through the recession. But if the partisan dispute continues to delay the issuance of additional fiscal stimulus, that could seriously impact consumer spending, which is the main driver of U.S. gross domestic product, and potentially lead to a remarkable increase in loan and credit delinquencies. Consequently, that would put financial stocks in huge trouble, and those are considered to be the backbone of the U.S. equity markets.
As the stock mania is still spreading across the nation, the brand new group of investors that just entered the markets is affirming to be getting increasingly rich. However, you only truly make money when you leave the markets, and most of these earnings are still on paper. Considering that every other stock market bubble in U.S. history has ended in a dramatic crash, John Hussman recently noted that this is our generation’s moment of peak financial insanity: “nothing so animates a speculative herd as a parabolic price advance in an asset detached from any standard of value. I am convinced that future generations will use the present moment to define the concept of a reckless speculative extreme, in the same way our generation uses “1929” and “2000”.
At this point, it’s just a matter of time until a stock price correction occurs, and a decline of anything over 50 percent is likely to be too much for our system to handle. In other words, it would essentially end our financial system as we know it, sparking a catastrophic collapse that would drag numerous stocks straight into rock bottom, while also causing much more economic pain than we have experienced so far. As we wait to discover what will be the next trigger event, you should start getting prepared to watch the most epic stock market crash of all time.
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