Where Will You Be When the Music Stops Playing?
When it comes to stock market crashes and financial crises, you can often feel like you’re playing a game of musical chairs. Those who see the crash coming and protect their assets ahead of time are the ones who are often best protected. That includes investors who decide to invest in gold, silver, or other hedges to safeguard their investment portfolios. But investors who don’t see the crash coming, or who decide to stay in markets just a little too long, risk massive losses.
Everyone wants to be the savvy investor who sells right at the top of the market, avoiding all the pain and heartache that comes along with stock market crashes. But not everyone can do that. And when the stock market’s game of musical chairs stops playing and everyone rushes to take a seat, will you be one of the lucky ones, or will you be left out in the cold?
Unlike rounds of musical chairs, in which only one player is left out while everyone else remains in the game, in stock market crashes it’s only those who get out early who benefit. It’s an incredibly small minority of investors who have both the knowledge to realize that a crash is imminent and the discipline to resist the siren call of getting back into markets to realize every last penny of gains. Here are a few reasons markets are still doing better than they should, and why you should be careful of making rash choices.
1. Stock Markets Have Recovered From Lows
The stock market crash in March left millions of investors scarred, with the Dow Jones and S&P 500 losing over 30% of their value in just a few short weeks. Since then, indices have recovered and made gains of over 25%. For those investors who invested at the bottom, that’s a pretty sweet gain for only about a month of investing. And those types of gains may lure many an investor who had sworn off stocks. But how sustainable are those gains in the long run?
There are a few things buoying stocks right now, but investors who are looking at long-term growth need to be wary, particularly with an economy that is headed for recession.
2. Continuing Stock Buybacks
Much of the stock market growth of the previous years has been due to corporate stock buybacks. Companies have taken advantage of low interest rates to issue cheap debt and use the proceeds to buy back their stocks. That boosts earnings per share, a key metric used to determine executive compensation. It also boosts the value of the stock options that form a major part of most corporate executives’ compensation packages.
Apple is expected to buy back another $75-100 billion of its stock, a move that will likely help keep its stock value afloat. But how many other companies can afford to continue these costly buybacks? With economic activity slowing, many companies are rushing to conserve cash and improve their financial situation, with buybacks not on the radar screen. And as buybacks slow down, so too will the short-lived recent gains in stock markets.
3. Professional Investors Still In It
While most of the country remains hunkered down at home, professional investors on Wall Street are still actively trading. In many respects, this shows the casino-like atmosphere of modern-day investing. With an economy headed into recession and with corporate earnings likely to show some of the worst declines ever, there are still thousands of investors trying to trade stocks in the belief that they will somehow magically rise in value in the future.
It’s mind-boggling to see just how overvalued stock markets are today, completely out of touch with the reality that the US economy is nearly completely shut down. Professional traders are essentially making bets that pharmaceutical companies will come up with a coronavirus vaccine, or that airlines will get federal bailouts. But if their bets go bad, what then? Maybe they can afford to take a big loss, but can you?
4. Stimulus Money
Finally, there’s a pervasive belief that now that the federal government and the Federal Reserve are involved in bailing out the economy, everything will get better. Those who adhere to that way of thinking believe that there’s no problem that unlimited amounts of money can’t solve. But the reason the economy was on the verge of a recession was precisely because there was too much money created to “solve” the last crisis.
That huge amount of money creation plus a decade of low interest rates is what spurred the stock market bubble and the corporate bond bubble that are now popping. And with over 25 million Americans now out of work, the thought that keeping those bubbles propped up with trillions of new dollars will somehow lead to an economic recovery is putting the cart before the horse.
The reality is that we’re facing an economic crisis that will make 2008 look like nothing. Once the economic lockdowns are lifted, thousands of businesses will have failed, millions will remain out of work, and it will take months, if not years, for the economy to recover. Investors today need to realize that the boom of the past few years is over. These are likely the best times we’ll see for a long time to come, and those who don’t understand that and don’t take steps to protect their investment portfolios will learn that the hard way.