Three Essential Ways to Prepare for the Next Sell-Off

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It was one of the exciting times in history to be an investor.

Stocks were soaring to new highs.  Investors were pouring money into stocks on the idea of an improving economy.  Optimism was exceptionally high.  Unemployment was at historic lows.  Thousands of people were becoming millionaires every day.

Investors were mortgaging their homes just for a piece of the market action.

Stocks quickly became a “sure thing.” Investors couldn’t lose.

At least, that’s what people thought until the Crash of 1929 caught them off guard.

Eighty-nine years later, we’re right back where we started.

Stocks are soaring to new highs.  Investors are pouring billions into stocks on an idea of an improving economy.  Optimism is exceptionally higher.  Unemployment is at historic lows.  And up to 1,500 people are becoming millionaires each day.

Just like 1929.  

The other similarity – not many are prepared for a repeat of 1929.  In fact, as many as 75% of Americans are as prepared for an eventual crash as they were in the roaring 20s.  

Granted, none of us have a crystal ball.

We can’t tell you with great certainty exactly when the next crash will happen.

But what we can tell you is, it’ll catch many of us off guard – AGAIN.

All as markets have become ridiculously overvalued, stretched well beyond fair valuation just as we’ve with the previous crashes in 1929, 1987, 2000 and 2008.

History is our guide

In 1929, rampant speculation sent the Dow Jones up 300% between 1923 and 1929.  Traders and investors believed stocks could only go up. Speculation forced stocks to unbelievable highs with unjustifiable valuation.  Then, it all fell apart.  

Between 1929 and 1932, the Dow Jones lost 86% of its value.

In 2000, dot-com optimism sent the Dow Jones to nearly 11,750 until unjustifiable valuations and greed sent it back to a low of 9,731.

In 2008, rampant speculation sent the Dow Jones to a high of 14,038 on the heels of a housing boom.  Americans were buying homes they couldn’t afford.  Stocks were exploding on economic optimism and unjustifiable valuations, just like in 1929 and 2000.  

Then, it all fell apart.

The Dow Jones would sink to 6,500.

Even today, stocks are soaring on high levels of optimism and unjustifiable valuation.

That could cost us… especially those that are not prepared.

As I’ll remind you, none of us will be able to time the exact date of the next crash.  It’ll catch many of us off guard, just as we’ve seen in previous meltdowns.

Stocks are clearly in a bubble

Like all bubbles, this one could soon burst.

Right now, the U.S. economy has been rallying on cheap money, massive amounts of debt, and irrational exuberance.  History has proven that it can’t last, though.  In 1929, 1987, 2000, and 2008, markets soared just as they are right now before horrible stock market crashes.  

And to be honest, we’re now long overdue.

For one, there’s far too much euphoria and the feeling we “can’t lose.”

At 25.63, the S&P 500 price to earnings multiple is the highest it’s been since 2000 and 2008.

At 33.2, the Shiller P/E ratio – which examines company valuations over 10 years and adjusts for inflation – is the highest it’s been since Black Tuesday 1929.

The S&P forward P/E ratio compares current market prices to average earnings over the last 10 years adjusted for inflation.  And what it has exposed is terrifying, especially over the course of 2017.  The last two times it was this high – or higher – markets crashed not longer after.  

In 1929, the ratio sat at 30.  The Dow Jones would crash from an October 1929 high of 352.69 to 198.69.  In 2000, the ratio sat at 44.19 at the start of 2000.  Not long after, the Dow Jones would slip from 11,638 to 9,731. In August 2017, it was back to 30.13.  

At 33.2, we’re nearing highs we haven’t seen in quite some time.  

Price to sales ratios now sits at highs.  Price to book ratios are back to 2008 levels.

We could go on for pages.  But you get the idea that stocks are incredibly overvalued.

Problem is – optimism is still running amok.  

In fact, according to the Yale University Stock Market Confidence Index, more than 90% of investors believe the market could run higher over the next 12 months.  Even with classic bubble-like conditions, they’re not paying attention.

But in all honesty, the market isn’t cheap anymore.  In fact, it’s overvalued when compared with its history, which absolutely poses risk to upside.  

While none of us can predict the next crash event, we can help you prepare for it.

These days, it’s not a question of “if,” but “when?”

Tip No. 1 – Have Discipline

According to Bunker Riley:

“Investments do go down and you need to accept that it is not an unusual occurrence. We’ve been lulled into a false sense of security during the last couple of years and you have to remind yourself that you cannot expect high positive returns year in year out without the occasional financial storm. Investing isn’t easy and coping with setbacks is part of the investment experience. Good investors try to keep things in perspective, which is easier said than done, but if a correction does eventually come, try not to see it as anything other than normal.”

When markets fall apart, we tend to get a bit emotional.  Logic goes right out the window.  Discipline means holding on to good stocks, even if they move lower.  It also means avoiding the desire to make speculative, risky bets hoping to break even.  

We have to remember that markets are resilient.  They don’t stay down for long.

Also, be willing to see out the “blood in the streets” trades.  

When markets crash, investors are typically presented with outstanding buy opportunities in oversold stocks that no one else wants to touch.  

In short, remain calm and focused.  Don’t sell out of panic.  Just sit tight.

If you take a look at this 48-year chart of the Dow Jones you can clearly see it pays to stay invested even in the worst of times.

Tip No. 2 – Use Precious Metals in a Bear Market

When markets turn south, investors typically flock to precious metals like gold and silver.  Therefore it’s always wise to keep a small percentage of your portfolio in precious metals as a hedge for a potential market meltdown.  

We can buy an ETF like the SPDR Gold ETF (GLD) for example as a hedged bet.

Given the fact that precious metals act as a great form of insurance against global chaos and stock market meltdowns, it’s one of the safer tools.  Gold, for example, will increase in price in response to any number of potential events; a crash the outbreak of war; pandemics; major uncertainty; interest rates; money “printing;” a decrease in the value of the dollar.

Tip No. 3 – Be Well Diversified with Bearish Investments

Some interesting ways to prepare for downside include buying:

  • The Pro Shares Short S&P 500 ETF (SH)
  • The Pro Shares Ultra Short S&P 500 (SDS)
  • The Pro Shares Short Russell 2000 (RWM)

It’s also a good idea to use put options as an insurance policy.  

Remember, options give you the right, but not the obligation, to buy or sell a security at a fixed price at a future date. One strategy for protecting an entire portfolio is to buy a put option on an exchange-traded fund like the SPDR S&P 500 ETF. Buying a put is like homeowner’s insurance in that investors pay a small premium to protect a much larger and more valuable asset, he says.

If the broader market falls, the value of the put increases, and the put owner can sell the option, using the proceeds to help offset losses in a portfolio.

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