This post is was originally published on Investor Junkie
As I write, the stock market is having more rise and falls than a ship in a storm.
Since the January 2018 stock market high of 26,616.71, the Dow Jones has lost 10% in value. Almost $2 5rillion in value has disappeared into thin air. Ouch!
The decline officially puts us in correction territory.
It sucks to lose money. One of Warren Buffett’s rules to investing is don’t lose money. The second rule? See rule #1.
Keep in mind, though, that since Election Day 2016, we’ve had a huge run-up in the stock market. In my opinion, too much, too fast.
From the low of 17,888.28 we saw on the day of the election, the market’s risen to a peak of 26,616.71 — a 49% increase. That’s a huge jump and doesn’t even include the gains we’ve seen in the prior seven years.
It’s been an amazing run, but a correction is healthy and needed.
This correction has been attributed to last Friday’s report of wage growth, fears the Federal Reserve will have to increase rates even faster, and a higher rate of inflation.
Gone are the days of easy money by the Fed.
We haven’t had a correction in a few years. So it is healthy and needed. Nothing can or show go up forever.
So the question is: Is this the end, or is there more to be expected?
What Is the CAPE Ratio?
There are many metrics to determine how cheap or expensive the stock market is.
One metric I like is the CAPE ratio (otherwise known as the P/E 10 or the Shiller P/E ratio). It was invented by value investors Benjamin Graham and David Dodd and then modernized by economist Robert Shiller as a way to smooth out earnings — unlike a forward PE ratio, which is based upon estimations and manipulated expected earning reports.
CAPE uses the S&P 500 earnings for the past 10 years to determine the valuation of the stock market. It also takes inflation into account by using the Consumer Price Index (CPI).
As of today, the CAPE ratio is 31.85
What exactly does this mean? It means we are at the third most expensive time in history — trailing only the dot-com stock market bubble of 2000… and 1929.
Head for the hills! Sell everything and put your money under a mattress.
Markets return to the mean, and we are nowhere near it.
No, the CAPE ratio doesn’t mean that it is assured we are going into a big stock market correction.
It’s simply an indicator.
It does mean the stock market isn’t cheap, but it doesn’t mean it can’t go higher from where we currently are.
Eventually, Henry will be right.
If you listened to his advice and got out of the stock market, you would have missed all of the recent stock market gains.
Same if you took the advice of economist Paul Krugman when Trump won the election. Krugman couldn’t have been more wrong.
What Does All This Mean?
Now, I don’t pretend to be an all-knowing market wizard. As economist John Maynard Keynes said, “The market can remain irrational longer than you can remain solvent.”
Even in the currently high evaluation of the stock market, for the long term (10 years or longer) there isn’t any other better place to see growth with your money.
If you are looking for some advice, here’s what you should do.
If you are close to retiring in the next five years, you should take some money out of the stock market. The past nine-year run-up has been great, but expected future returns are muted at best. You’ve won the game and now is the time to position yourself for more income than for growth in the stock market.
That’s not to say the stock market couldn’t go higher from here. It very well could, though markets tend to return to the norm.
If you are an investor in your 20s, 30s or 40s, what should you do? Take the advice of Jack Bogle, who stated it best: “Don’t do something; just stand there.”
Our very own instincts of fight or flight actually make us horrible investors. You have many years before retirement and still should be in the market. Studies have shown inaction is better, and it is very hard to time the market.
Instead of focusing on what you can’t control, focus on what you can: annual fees, your savings rate and taxes.