For the first time in ages, I’ve started worrying about the next stock market crash. Having witnessed the October 1987, 2000-03, 2007-09, and spring 2020 crashes, I’ve seen my fair share of market meltdowns.
What causes stock market crashes?
On all four occasions above, two problems eventually brought down stock prices. The first was overvaluation, driven by investors paying premium or even extravagant prices for financial assets.
The second problem was bullish sentiment leading to irrational exuberance, when investors abandon caution and sensible investing goes out of the window in favour of wild speculation. Alas, I can see both problems emerging today.
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The gains look great, but…
My hero, mega-billionaire and philanthropist Warren Buffett, advises investors to be, “fearful when others are greedy, and greedy when others are fearful”.
I am getting alarmed by the US stock market, but why have I become pessimistic? Because I feel that the US market has come too far, too fast since its autumn lows.
At its 52-week low on 13 October, the S&P 500 index bottomed out at 3,491.58 points. As I write on Friday afternoon, the index stands at 4,537.41. In other words, the main US index has surged by over 1,045 points in 9½ months — jumping almost exactly 30%.
What’s more, the index leapt by 16.9% in the first half of 2023 alone, one of its strongest first-half performances in decades. Meanwhile, the tech-heavy Nasdaq Composite index soared by 32% in its best first half since 1983 — when I was just 15 years old.
To me, this suggests that investors’ hearts are ruling their heads, so they’re paying excessive prices for US stocks today. Also, the utter supremacy and dominance of the ‘Magnificent Seven’ Big Tech stocks during this US rally is another big concern.
Could stocks crash 64%?
By the way, one so-called ‘perma-bear’ who predicted the 2000 and 2008 stock market crashes is warning that US stocks might collapse by 64% from current levels.
This week, John Hussman warned that the US market has become overheated, describing current valuations as “the most extreme yield-seeking speculative bubble in US history”. He added, “Yes, this is a bubble in my view. Yes, I believe it will end in tears”. Yikes.
Personally, I don’t believe that stocks will collapse as Hussman fears. Thus, I don’t expect the US market to crash in 2023. But I do worry that today’s over-extended valuations will inevitably drag down future returns to come.
I prefer cheap UK shares
Instead of buying pricey US stocks, I’ve turned my attention to the undervalued UK stock market. In both historic and geographic terms, it looks far too cheap to me.
At present, the UK’s elite FTSE 100 index trades on a modest multiple of 10.7 earnings, for an earnings yield of 9.3%. This means that the Footsie’s dividend yield of 4.1% a year is covered almost 2.3 times by earnings.
Though British consumers are being hammered by rising interest rates, soaring prices, and sky-high energy bills, this isn’t a big concern. That’s because the vast majority (at least 70%) of FTSE 100 earnings come from overseas and, therefore, are not reliant on UK growth. And that’s why I shall shun US stocks in favour of bargain UK shares for the rest of 2023!
