In the last post of this series, The Coming Bear, I discussed the reasons why I believed the economy was headed for a housing-led recession in 2007. If this turns out to be correct the stock market is going to fall dramatically and will probably challenge the 2002 lows.
Even if I am wrong and the economy continues to grow at its current pace with corporate earnings rising along with it, the stock market is overvalued by almost every measure:
- P/E ratios are well above the historical average of about 15. Typically the beginning of a bull market is signaled when P/E ratios fall below 10. Currently, the S&P has a P/E ratio over 18.
- The Dow/Gold ratio currently trades at 19. This ratio has equaled 1 a few times in the past which made for a great time to buy the Dow and sell gold. Right now gold is the better buy.
- The Dow dividend yield stands at 2.17% which is less than half of the yield on the 10-year treasury. Many times in the past Dow stocks were yielding over 5%
For these reasons it is very hard to imagine that stocks will produce above average returns in the future. Now if I am correct and the economy does suffer a housing-led recession and earnings do fall, then we could see stock prices get hit very hard.
Almost all sectors of the stock market should be negatively affected including retailers, technology, transports, financials, commodities, and of course real estate. Only gold stocks will be spared since their performance depends not on economic growth, but on monetary and foreign exchange conditions.
If you really want to protect yourself from the coming bear market, the best strategy is to sell all of your stocks. Now this may sound heretical to you since you have always heard that stocks are the best performing asset class over the long term. But this depends on what is defined to be long term.
Consider that from 1968 to 1979 the best performing asset was gold which increased 19.4% annually. Stocks on the other hand gained only 3.1%. If you owned stocks during this period you actually lost money since inflation was running at 6.5%.
I am not sure how you feel, but I feel 10 years is a long time and I would hate to lose my money over so many years. So it is possible stocks can perform very badly for a long time. As discussed in this series of posts I believe we are in such a period. The bear market began in 2000 and should last for around 10 years. If you want to preserve your investments for the rest of this decade do the most logical thing… sell your stocks!