Investments in the stock market have needed an iron grip for most of the past year. The unprecedented nature of the coronavirus disease (COVID-19) pandemic has turned societal norms upside down, ended the traditional work environment and cast a dark cloud over equities during the first quarter of 2020. It only lasted 33 calendar days. (less than five weeks) for the criterion S&P 500 (SNPINDEX: ^ GSPC) to lose more than a third of its value.
It has therefore mostly been a roller coaster of joy since March 23rd. The S&P 500 ended 16% higher in 2020 (this is almost double its average annual return over the past forty years), and it starts on 2021 on a high note. Up to and including Wednesday, February 3, the index that is widely followed was 2% higher, to date.
But if history proves accurate, investors should not become too comfortable with the strong start to 2021.
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Be prepared for a 20% stock market crash
Although day trading and momentum are gaining momentum for the first time in the first few weeks of the new year, it is the growth in operating earnings that is sustainably increasing long-term equity valuations. Therefore, it is always important to pay attention based on the market, no matter what is going on.
The figure that investors should worry about properly is the Shiller price-to-earnings ratio (P / E) for the S&P 500. It differs from the standard P / E ratio in that it is based on the average inflation-adjusted earnings of the previous ten. years, as opposed to just the earnings of a single year.
Looking back 150 years, the S&P 500 averages a Shiller P / E of 16.78. The Shiller P / E ratio is admittedly much higher over the past 25 years. The advent of the internet has broken down the information barriers for retail investors, and the historically low lending rate for more than a decade has fueled lending and created a fire among growth stocks.
But as of February 3, the Shiller P / E for the S&P 500 is knocking at the door of 35 – more than double the long-term average. To put this figure in context, there have only been five periods in history in which the Shiller P / E ratio was above 30 and remained there during a bull market run. Two of these events – the Great Depression and the dot-com bubble – led to the biggest setbacks stocks have ever seen. Two other events (excluding the current move) have taken place over the past three years, leading to 20% and 34% in the S&P 500 respectively.
In other words, when the Shiller P / E ratio crosses above and maintains 30 during a bull market rally, it ultimately results in a minimum drop of 20%.
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There are other reasons to worry
These are currently not just protracted valuations. Nose-blood premiums baked in the stock market suggest the COVID-19 pandemic will soon be a thing of the past. That may not be the case.
Take, for example, a look at the latest results from the Kaiser Family Foundation (KFF) COVID-19 vaccine survey. In mid-January, KFF asked respondents about their willingness to receive at least one dose of COVID-19 vaccine for free. About 6% had already been vaccinated, while another 41% were willing to get it as soon as possible. Meanwhile, almost a third (31%) of respondents were in the “wait-and-see” mode, with a combined 20% “definitely not getting it” or only if necessary (note, numbers do not count) to 100 not)% due to rounding).
This is about half of the population that is not prepared to stand up for a COVID-19 vaccine now. According to recent comments from dr. Anthony Fauci, it will take between 70% and 85% vaccinations to bring about herd immunity. In other words, the pandemic may not be over for a long time.
To build on this point, many working Americans and their families are counting on continued federal government assistance. Millions of workers have been laid off or laid off, and some of those still working have seen their hours diminished. If biased disputes on Capitol Hill continue and additional fiscal stimulus is delayed, it could have serious negative consequences for consumption (it is the leading driver of the US gross domestic product) and could lead to a significant increase in loan and credit crimes. . That would be bad news for financial stocks, which many see as the backbone of the US stock markets.
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Stay the course and target winners
Nevertheless, even if there is a stock market crash, it is a smart move for investors to keep pace and contribute to innovative and award-winning businesses.
JP Morgan Asset Management is one of the most telling statistics on the decline of the stock market. After analyzing 20 years of returns for the S&P 500 with multiple end-years, one figure stands out: about 50% to 60% of the best gains in the single session in the market take place within a few weeks after the worst performances in the one session. This is a flashy way of saying that if you run to the exit, you will almost certainly miss some of the biggest start days of the market. Missing even a handful of these big days can hurt your wealth.
In addition, data from Crestmont Research show that in the S&P 500 history, there has been no consecutive 20-year period in which investors would have lost money. If an investor bought an S&P 500 tracking index and held it for at least 20 years, they usually achieved a high single or low double-digit annual total return (ie dividends included).
If a stock market crash in 2021 comes to the fore, the best plan is to keep the rate and contribute to the investments that keep winning.