This ALWAYS Happens Before A Stock Market Crash

The current market is described as being in a "parabolic meltup phase," with many questioning its sustainability. Year-over-year, the S&P 500 has seen a significant increase, and valuation metrics like the Schiller PE ratio are at historic highs, comparable to the dot-com bubble. Concentration in the market, particularly in AI, is also nearing levels seen during the 2001 tech bubble and Japan's economic bubble. This has led to concerns about the highest risk levels since 2021. Objectively, the stock market's performance seems counterintuitive given global issues like Middle East conflicts and rising living expenses. Comparisons are being drawn to the 1920s leading up to the Great Depression and Japan's economic bubble. Japan's market experienced exponential growth fueled by cheap interest rates, leading to a cycle of borrowing against inflated land values for further investment. This bubble burst in 1989, resulting in a market crash and a prolonged economic downturn for Japan. Similarly, the dot-com bubble saw tech stocks plummet. Today, metrics like the CAPE ratio are significantly above historical norms, and the Buffett indicator is also well above its trend. The concentration of the top 10 stocks in the S&P 500 now exceeding the dot-com peak adds to these concerns. Arguments for the market being in a bubble include stocks being expensive relative to profits, with the S&P 500's forward P/E exceeding historical averages. Demographic trends, such as declining birth rates and an aging population, mirror some of the factors that contributed to Japan's economic struggles, potentially straining social programs and increasing taxes. Additionally, a decline in organic savings, high debt levels, and youth unemployment suggest an economy that may be artificially propped up, with fundamentals not supporting current valuations. However, there are also arguments suggesting the market may continue its upward trajectory. Despite high valuations, companies are generating substantial profits, exceeding those seen during the dot-com era. While the Magnificent 7 stocks are performing exceptionally well, smaller companies are also showing signs of growth, which could reduce volatility. Prices don't typically fall without an unforeseen catalyst, and current market performance is not historically anomalous in terms of timing relative to past crashes. Earnings and cash flows are reported as strong, and forward earnings are below the 2001 peak. The lack of attractive alternatives to investing, with cash losing value over time, also pushes investors towards the stock market, despite its short-term risks, due to its potential for long-term upside. Fidelity has identified warning signs, including companies spending more than they earn, interconnected business ownership leading to systemic risk, debt growing disproportionately to profits, potential limitations on AI growth due to energy consumption, and the impact of rising borrowing costs on profits. Despite these concerns, Fidelity believes AI could drive further market growth as smaller companies adopt the technology. Some analysts argue that historical valuation metrics, like the CAPE ratio, should be viewed in the context of the last 30 years, post-internet adoption, where valuations are less extreme. Earnings are strong, and the stock market often looks towards future expectations rather than current conditions. The theory that the stock market is rising solely because the dollar is falling is also examined. Historical data suggests a weak correlation between the dollar's value, money printing, and stock market performance. Other factors, such as interest rates and investor sentiment, appear to have a greater impact. In conclusion, while the market is undeniably expensive and carries risks, a repeat of Japan's scenario would require earnings to stall completely, and the S&P 500 to reach significantly higher levels. The current market environment suggests continued potential for price increases, though caution is advised. Diversification, maintaining an emergency fund, and dollar-cost averaging are recommended strategies. The market can remain irrational longer than an individual can remain solvent, as illustrated by historical examples like Isaac Newton's losses during the South Sea bubble. The advice given is to invest consistently, diversify across U.S. and international markets, and maintain a portion of assets in safe havens like treasuries. Dollar-cost averaging is repeatedly emphasized as a successful long-term strategy, often outperforming market timing attempts.