This article appeared in the Albuquerque Journal on September 30, 2024.
Should we expect a major downturn soon in the US stock market? No one knows for certain. Although there was a minor correction at the start of the pandemic in March 2020, the stock market recovered quickly. There has not been a major correction since the 2008 financial crisis, when the S&P declined 54%. That was 16 years ago, and some experts are saying we’re due for a correction.
The question is not whether a correction will occur, because the US stock market has never promised a steady upward climb for investors. The question is when will the next correction occur.
Yale Economics Professor and Nobel laureate Robert Shiller was interviewed in April 2024 by Jeff Sommer of the New York Times. In the April 5, 2024 article Dr. Shiller suggested that the US stock market is overpriced based on corporate earnings. Sommer stated, “This reminds Professor Shiller of the rallies of the 1920s and the dot-com boom, which both ended badly.”
On July 29, 2024 Ron Surz wrote an article for the Advisor Perspectives newsletter, titled “Baby Boomers Better Get Out of the Stock Market Now.” Surz provides details on four major US stock market crashes that all required over five years to recover. The longest — the great depression that began in 1929 — required 25 years to recover.
Surz states that young investors probably have enough time to recover from a significant downturn, but Baby Boomers do not. According to Surz, the US stock market is currently at its highest price level ever.
James Mackintosh wrote a fascinating article for The Wall Street Journal on August 16, 2024, in which he reviewed the current levels for three investment metrics. He included the CAPE (cyclically adjusted price-to-earnings measure), the forward P/E (price-to-earnings), and the Fed Model. The CAPE was created by economist Robert Shiller (the same Nobel laureate mentioned above), and it compares the current price of the S&P 500 with the average of the previous decade’s corporate earnings. The CAPE is now over 35, which is higher than in 1929. This suggests that the S&P is overpriced. The forward P/E and the Fed Model also suggest the US stock market is overpriced.
What’s an Investor to Do?
First, we must recognize that the metrics and predictions may be wrong, and the US stock market may soar. Therefore, I do not advocate overreacting; however, I recommend one important strategy:
Monitor the asset allocation in your investments, and determine if it is appropriate for your comfort level with risk and your goals.
The field of behavioral finance tells us that our risk tolerance is frequently less than we expect when the stock market plummets. Investing involves emotions, and we often behave irrationally. I do not believe the 60% equities, 40% fixed-income asset allocation that the financial industry often recommends is appropriate for everyone. I prefer to keep my family’s equity percentage lower than 60%, and I readily admit I am a conservative investor.
I also do not recommend relying on your financial advisor to monitor the asset allocation for you. With the strong US market performance in 2023 and (so far in) 2024, many portfolios are out of balance, and the equity percentage may be too high in your investment accounts.
I encourage you to educate yourself on monitoring your investments. One tool I recommend is Morningstar Investor, which is an online program that costs $249 per year. When I sold my firm and retired, I lost access to all the fancy software programs I used for monitoring my clients’ investments, for retirement projections, and tax planning. Morningstar Investor is not as robust as the Morningstar software program I previously used, but I still like it very much. It allows me to research mutual funds and exchange-traded funds, as well as build portfolios and monitor their performance. In addition, I receive a daily email that contains many informative articles. This is a great way to educate yourself on financial topics.
“Sequence of Return” Risk
A relatively new concept in the financial industry is called “sequence of return” risk. This theory suggests that the return during the first few years after retirement are the most important for longevity of a retiree’s portfolio and that is a time to not be overly aggressive. This concept suggests that people who have been retired for a long time (perhaps those in their late 70s or 80s) can use a more aggressive asset allocation because they have fewer years remaining to rely on the portfolio. This concept conflicts with the common thinking that investors should gradually become more conservative as they age, especially after retirement.
Whether you agree with the concept of “sequence of return” risk or not, being overly risky with your investments may not be wise when experts and metrics are suggesting the US stock market is overpriced. But every investor must decide for themselves. I like to sleep well at night, and I’ve always liked the adage “slow and steady wins the race.”
Donna Skeels Cygan, CFP®, MBA is the author of The Joy of Financial Security. She owned a fee-only financial planning firm in Albuquerque for over 20 years before recently retiring. She welcomes emails from readers at [email protected].