Liberating Stock Price Crash Thought #1 — It’s Virtually Inevitable
I used to worry about the possibility that we will soon see a stock price crash. For obvious reasons. I have lots of friends with high stock allocations. I don’t want to see them hurt.
The first 54 months of The Great Safe Withdrawal Rate Debate have taught me that I was wrong to think that a stock price crash is likely. I now see that it is not just likely, it is all but inevitable.
So I don’t worry about it too much anymore.
Things that are possible or likely generally worry you more than things that are inevitable. Once you come to accept something as inevitable, whatever it is inside you that is in charge of causing you to worry seems to stop pumping out so many worry chemicals into your bloodstream. You no longer direct mental energies to the task of trying to fight off the possibility that is the focus of your concern. You accept what you know is coming. You even start planning for it.
When you accept something as all but inevitable, it’s just not as frightening anymore.
Liberating Stock Price Crash Thought #2 — Avoiding a Price Crash Would Be More Painful Than Enduring One
We are now (this article was written in November 2006) at P/E10 levels nearly double the fair-price P/E10 level of 14. On the three earlier occasions when we ventured into the la-la land where stock prices reside today, we experienced an average price drop of 68 percent. That’s why I say that a price crash appears all but inevitable.
It remains possible to imagine a way to avoid a big price drop, however. What if the scenario that has applied for the past seven years were to extend far into the future? What if the prices of the major stock indexes were to remain at the same general level while inflation ate away at the wealth of those holding shares in those indexes? Isn’t that an alternate means by which stocks could travel the path back to reasonable valuation levels?
I think it is. It has never happened that way before. My sense is that the reason why a stock price crash becomes nearly inevitable when we get to these valuation levels is that even remaining at the same price level for many years eventually causes investors’ confidence in stocks as a long-term investment to falter, and the faltering confidence brings on a big price drop. So I don’t think it is likely that stocks are going to remain dead money for all that much longer. I don’t entirely rule out the possibility, however.
I question, though, whether having stocks remain dead money for long into the future is such a great thing for middle-class investors. Stocks are as a general rule the most powerful wealth-building asset class available to us. We have temporarily lost access to this major wealth-builder. Is that a plus? I sure don’t see how.
The reason why some view the scenario of stocks being dead money for a long time in a positive light is because it appears on the surface to be a more appealing scenario than experiencing a big price drop. A more in-depth analysis suggests quite the opposite. Having stocks remain dead money for many years may well be one of the worst of all possible paths back to reasonable price levels.
Imagine a retiree who retired at age 55 in January 2000, and who placed his confidence in one of the conventional-methodology safe withdrawal rate (SWR) studies in planning his retirement. He determined that he could get by on $40,000 of spending per year, and he retired with a portfolio of $1,000,000 invested 80 percent in S&P stocks. That’s enough, according to many of today’s retirement planning tools. It’s far short, according to the New School SWR studies, which show the SWR at that time for an 80 percent stock allocation to have been 1.6 percent. This retiree is in all likelihood going to experience a busted retirement at some future date, but he doesn’t know it yet.
Which scenario is better for this retiree? One in which he experiences a gut-wrenching price drop early in his poorly planned retirement? Or one in which his portfolio value is slowly eaten away by inflation and in which he learns of the analytical errors of today’s retirement planning tools at some date far off in the future?
I have come to believe that the latter scenario is in some ways the worst of all possible scenarios. It may be that a stock price crash is just what this retiree needs to wake up to the realities of long-term stock investing at a stage of life in which learning them can still do him some good.
If the Year 2000 retiree holds back from selling stocks until the stock price crash does a good bit of harm to his portfolio value, he will need to return to work. His chances of finding appealing employment are obviously better the earlier in life he comes to terms with the realties.
A stock price crash is going to be painful to those who bought into the bull market illusions that have done so much harm to so many middle-class investors in recent years. The reality, though, is that stretching out the pain does not make it easier to take.
Liberating Stock Price Crash Thought #3 — A Big Price Drop Will Balance the Scales of Justice a Bit
Different types of investors are affected in different ways by wild bull markets and by the wild bear markets that inevitably follow them. There has never been a better time in the history of the United States to begin investing heavily in stocks than in the early 1980s. There has never been a worse time in the history of the United States to begin investing heavily in stocks than in the late 1990s and the early 2000s.
Were the investors who began investing heavily in stocks in the early 1980s all incredibly smart people? Not really. Were the investors who began investing heavily in stocks in the late 1990s and in the early 2000s incredibly dumb people? I sure don’t think so.
Many of those who think of themselves as smart because they received outsized investment returns as the result of buying stocks in the early years of the most wild bull market ever were just lucky to have been born at a time that positioned them to be starting to earn nice incomes at the start of the 1980s. Many of those who in future years will come to think of themselves as dumb because they were taken in by the bull market illusions just before the wild bull was about to be replaced by an equally wild bear were just unlucky to have been born at a time that positioned them to be learning about how to invest at a time when the nonsense quotient in the investment advice offered by the most popular experts was at the highest level it has ever been.
There is nothing we can do to change the reality that the fates smile on some of us more than they do on others. As Paul Simon once observed in song: “Some folks portfolio values grow steadily, some folks portfolio values, they never grow at all — they just fall.” As the Bible tells us, those who started buying stocks near the tail end of a huge bull market will be with us always.
That said, it will be better for those who began investing in recent years if prices someday soon fall to a point where it becomes reasonable once again to look forward to exciting long-term returns from stocks. William Bernstein has reported that, in the event that stock prices remain at today’s levels for some time to come, the expected long-term return on stocks drops to 3.5 percent, about half of what it has been throughout the history of the U.S. market. Not good.
How can we overcome Bernstein’s dire prediction of poor long-term stock returns for years and years to come? By experiencing a healthy drop in stock prices. Bernstein isn’t predicting poor stock returns for as far into the future as the eye can see because something has happened to the U.S. economy making it far less productive than it has ever been before. He just understands that the weight of today’s la-la land stock prices is more than even the strongest economy in the world can overcome.
The medicine that my boy needs to take to get over his recent illness doesn’t taste good. But the results are sure nice to contemplate — a four-year-old once again running and jumping and playing and singing the way God intended. A stock price crash isn’t going to go down too easy either. In the long run, though, it will prove to be a good thing for those of us who were unfortunate enough to have become able to invest just at the time when the best investment class of all became so overpriced that it could no longer realistically promise the sorts of returns that it has provided through most of the history of the U.S. stock market.
Liberating Stock Price Crash Thought #4 — We Need to Get to Work Developing the Insights of the Past 54 Months
The Financial Freedom Community has done extraordinary work over the course of the past 54 months. I think it would be fair to describe the insights developed during the early chapters of The Great Safe Withdrawal Rate Debate as the most far-reaching insights ever developed by any internet discussion-board community.
Those insights have not yet been developed to the extent they need to be developed. We have had hundreds of community members putting forward exciting contributions. We have also had hundreds throwing obstacles in our path. And we have had hundreds leaving the community in revulsion over the tactics employed by those trying to find a way back to the Summer of 1999. The Campaign of Terror has hurt us big time. It’s been a stone cold drag.
All that comes to an end when we experience a stock price crash.
Will it hurt? Yes, it will hurt. Will we look back years later and conclude that the pain experienced in becoming able to push our Learning Together project into overdrive was worth it ten times over? That’s what I think is going to happen.
There are all sorts of exciting things that become possible in our community once the nonsense from the Summer of 1999 is finally laid to rest. The nonsense from the Summer of 1999 is getting old, real old. Truth be told, the nonsense from the Summer of 1999 has gotten so old that it is beginning to stink. Let’s move on.
Liberating Stock Price Crash Thought #5 — We Need to Learn How to Talk Sensibly About Stocks Again
I’m not a fan of huge bull markets or the huge bear markets that follow them. When I invest, I am putting my money at risk. I aim to be as calm and rational as possible when my money is at risk. Both huge bull markets and huge bear markets are times when rationality is lost in the wind and out-of-control emotions rule the day.
The intensity of the emotions we have seen in investors hoping that Bull Market prices can remain in place a few years longer is embarrassing to those of us who seek to plan for early retirement in a sober and serious and realistic way. It puts humans in a negative light to see them give in to feelings of greed and fear, the dominant investor emotions in out-of-control markets.
I believe that the times when investors learn the most about how to invest effectively for the long run are those sweet stretches of time when investor emotions are not so out-of-control. I like moderate prices not only because moderate prices provide the best returns for investors (stocks can generate a real return of 6.5 percent per year without valuations ever going above fair-value levels) but also because moderate returns provide the environment for the investors themselves to be smarter and kinder and more responsible and more caring (both to themselves and to their loved ones and to their fellow investors).
We are better people when the fear of returning to reasonable prices is not eating away at our insides. A stock price crash wouldn’t just be good news for most of us financially. It would be good news for most of us on a human level too.
That’s what counts the most, isn’t it?
It’s not just about being rich. It’s about feeling rich. So long as the prospect of seeing the inevitable stock price crash take place remains hanging over our heads, we are not going to be able to feel good about our investing lives. Once it actually takes place, the fear is gone. The stock price crash will set us free!
Let’s stop being frightened of the big price drop to come. Let’s invite it into our lives. Let’s welcome it. Let’s look forward to it. Let’s make plans to enjoy it when it comes.
I’m praying for a stock price crash, you know? I’m not praying that it come too soon, however. It would be nice to finish my book on investing first. Saint Augustine once implored his Maker: “Lord, please make me chaste — but not just yet!” So let it be with a stock price crash. Bring those prices down hard and do it soon, Dear God, but let this poor boy get the words written that he needs to get written in time to make some personal hay from all this nonsense too.
Is that so much to ask?