There’s a major market crash coming…

brace

Adopt The Position…

Investment wise, 2017 was as calm as a mill pond.

The stock market did not crash. There was no zombie apocalypse to speak of and The World continued a 4 billion year lucky streak by not ending.

My stock picks delivered 13.5%…just beating the FTSE All Share index which gave a total return of 13.1%.  13.5% was actually a shade below my past results which are currently running at 14% annualised over the last 21 years. If you start with £1m and grow it at 14% per year that turns into £15.7m over 21 years. Unfortunately, I started with nothing.

13.5% is not bad but under-performed a simple Vanguard S&P 500 tracker fund which in 2017 delivered ~21.8% in $ terms (with a lot less work).  This is a handy reminder that you can do well even if you know nothing about investing.

If history is anything to go by, these returns are probably too good to last forever.

We’ve had some warning signs.  I’ve been writing about the US market looking pricey for a couple of years now.  GMO Investment Management are now forecasting losses over the next 7 years for all mainstream asset classes other than emerging market shares.

Bitcoin

What could possibly go wrong?

And don’t get me started on the whole crypto-currency thing (which seems to have a similar effect on males under 30 to fast broadband plus internet porn).  Did these guys not read Day Trading : Frankie Goes to Vegas???

Its also interesting that in 2017, the stock market trounced UK property prices with the FTSE All Share delivering a ~10% capital increase which compares to 2.7% for UK housing according to The Halifax.  Could it be that, after the Brexit vote, the air is slowly coming out of the tyres of the UK housing market?

Contrary to folk stories that say “you can’t go wrong with property” the housing market and the stock market are both prone to crashes.  Its just that these crashes look different. In a housing market downturn, prices are “sticky” and slow to adjust downwards as sellers resist price cuts.  Transactions dry up, people stay put and it can take years for prices to adjust fully and the market to function normally again.

Much of the adjustment happens via inflation. In other words, house prices flatline for several years whilst inflation cuts those prices in real terms. The last proper UK housing crash was in 1990 and it took over 5 years for the market to clear and normalise.

Maybe we’re at the start of a 5 – 10 year property crash? If interest rates went back up to the 17% they reached in 1981, that would be very likely. But even if interest rates are held down, a long drawn out property slump is possible.   Who knows? You can’t predict, but you can prepare.

Its an old stock market saying that the market climbs up the stairs and goes down the escalator.  In other words, prices adjust downward quickly and could easily fall by say 30% in a week (e.g. October 1987) to restore the balance between buyers and sellers.  The process is much shorter and sharper and therefore much more visible in the stock market vs the housing market.  Plus the media know this scares people and keeps them hooked on their news product. So stock market crashes get a load of attention. Another reason why no news is good news.

We want to avoid the rookie mistake of failing to expect market crashes (which are a normal part of the process).  Like a clown, The Escape Artist has failed at this in the past, having cracked in the 2000-03 bear market and sold right at the very bottom….doh!

Its easy to invest effectively as long as you never panic sell during market crashes. There is no more important message than this in investing.

The Escape Artist has told you this before but I can’t be sure you were all really listening.  Now is as good a time as any to get The Godfather of Financial Independence back to drum the message into us all.

So today, I’m featuring an extract from JL Collins excellent book The Simple Path to Wealth to remind us that we need to toughen up to be good investors (as well as cutting our spending on donuts & soft furnishings and using our legs etc etc).

Here’s what Mr Money Mustache says about The Simple Path to Wealth:

You could probably fill an entire underground parking garage with all the books that have been written on the subject of investing alone…the problem is that most of those books are boring and you end up setting them down with a bookmark somewhere around page 25, never to return. 

JL Collins takes this old style of investment book writing and disregards it completely. He lights up the campfire and and just starts telling stories, and if those stories just happen to be about exactly what you wanted to learn about in the first place, your new knowledge is a happy side effect.

Although very few people actually follow it, I have found that the road to a wealthy life really is simple and enjoyable to follow, so it only makes sense that a book about it should have those same fine traits. This one does. 

So how should we deal with the coming market crash if we are invested in shares?  Here’s JL Collins:


JCPundits and professors say “treat the symptoms” of volatility.

They default to broad asset allocation. They would have us invest in everything and hope a couple of those puppies pull through.

To do this properly would require a ton of work. You would need to understand all the various asset classes, decide what percentage to hold of each and choose how to own them. Once you did that you’d need to track them rebalancing as necessary.

The result of all this effort is to guarantee sub-par performance over time while offering the slim hope of increased security.  I am reminded of the quote: “Those who would trade liberty for security deserve neither“.

I say:

Toughen up cupcake…

tougher-up-cupcake…and cure your bad behaviour.

This means you must recognise the counterproductive pyschology that causes bad investment decisions – such as panic selling – and correct it in yourself.  In doing so, your investments will be far simpler and your results far stronger.

To start you need to understand a few things about the stock market:

1. Market crashes are to be expected 

What happened in 2008 was not something unheard off. It has happened before and it will happen again. And again.  In the 40 odd years I’ve been investing we’ve had:

  • the great recession of 1974-75
  • the massive inflation of the early 1980s when mortgage rates were pushing 20%
  • the crash of 1987 (~30% fall in a week)
  • the tech crash of 2000-03

2. The market always recovers

Always.  And, if someday it doesn’t, no investment will be safe and none of this financial stuff will matter anyway.  In 1974 the Dow closed at 616.  At the end of 2014 it was 17,823. An impressive result through all the disasters.

All you would have had to do was toughen up and let it ride. Take a moment and let that sink in.

Everybody makes money when the market is rising. But what determines whether it will make you wealthy or leave you bleeding on the side of the road is what you do during the times it is collapsing.

3. The market always goes up

Dow JonesUnderstand that this is not to say it is a smooth ride.

It’s not. It is most often a wild and rocky road.

But it always goes up. Not every year. Not every month. not every week and certainly not every day.

But take a look at a chart of the US stock market 1900 – 2012.  The trend is relentlessly, through disaster after disaster, up.

4. The stock market is the best performing investment class over time

Bar none.

5. The future will have as many collapses, recessions and disasters as the past

Its not possible to prevent them.  Every time this happens your investments will take a hit.  Every time it will be as scary as hell. Every time all the smart guys will be screaming: Sell!! And every time only those few with enough nerve will stay the course and prosper.

This is why you have to toughen up, learn to ignore the noise and ride out the storm; adding still more money to your investments as you go.

To be strong enough to stay the course you need to know these bad things are coming – not only intellectually but on an emotional level as well.  You need to know this deep in your gut. They will happen. They will hurt.  But like blizzards in winter they should never be a surprise [TEA: South West Trains please take note].  And unless you panic, they won’t matter.

There’s a major market crash coming!! And there’ll be another after that!!  What wonderful buying opportunities they’ll be.

I tell my 24 year old that during her 60-70 odd years of being an investor, she can expect to see 2008 level financial meltdowns every 25 years or so.  That’s 2 – 3 of these economic “end of the world” events coming her (and your) way. Smaller collapses will occur even more often.

The thing is, they are never the end of the world. They are part of the process. So is all the panic that surrounds them. Don’t worry. The world isn’t going to end on our watch.  It is hubris to think it will.

Of course, over those same years she’s going to see several major bull markets as well.  Some will rage beyond all reason, along with the hype that will surround them.  When those occur, the financial media will declare “this time it’s different” with all the same confidence as when they claimed the end had come.  In this too they will be wrong.

But yer gonna have to be tough.


Further reading:

39 comments

  1. Timely, I think

  2. ladyaurora · · Reply

    I’ll be back reading this post when it happens!!
    What’s been concerning me is how long does it take for the market to recover and get back on top again?
    I spoke to a couple of people lately who said it took them 10 years to recoup their equity loses and get back to where they were.
    If your in drawdown and this happens what do you do ? I know about the 3-4 years worth of safe [cash] on standby to tie you over an an equity meltdown, but what happens if its 10 years???

    1. Hi Lady Aurora…

      Depends on whether you are in what I call the Wealth Accumulation Phase or the Wealth Preservation Stage.

      In the former, the new money you are investing from your high savings rate takes advantage of the drop and turns it to your advantage. Indeed, if you are in the early stages of building your wealth, a nice drop is a blessing.

      In the latter, your bond allocation serves that purpose as you rebalance.

      The key, as Escape Artist points out, is not to panic and sell. If you do, that’s when you lose.

      1. ladyaurora · ·

        Hi Thanks for responding. Im almost over accumulation phase now and more wealth preservation stage.My question was not about selling in a crash but what to do if in drawdown and the market takes 10 years to recover. I suppose what your saying is you would draw from the bonds/cash side for 10 years then?

      2. Basically, yes…

        …and, of course, drawing down on your cash/bonds is the same as adjusting your allocation. For more: http://jlcollinsnh.com/2014/08/25/stocks-part-xxvi-pulling-the-4/

      3. ladyaurora · ·

        @jlcollinsnh
        clicked on the link and love your site. thanks again,

  3. “The thing is, they are never the end of the world. They are part of the process. So is all the panic that surrounds them. Don’t worry. The world isn’t going to end on our watch.”

    Couldn’t agree more! For me is: Build a portfolio, with an asset-allocation that you can keep it up in the good and bad times. Rebalance. Keep it simple. Follow the path.

  4. Yep, the blowout sale on stocks is coming, and I’m getting ready to buy. It’s gonna be a hoot!

    And crypto….“which seems to have a similar effect on males under 30 to fast broadband plus internet porn”

    Great line by the way, hilarious!

  5. Nuala Soutter · · Reply

    Excellent article … what goes up …

  6. Thanks, EA…

    …for featuring that piece.

    Fun re-read for me!

  7. Slightly geeky, but I believe the Shiller PE could drop substantially when the losses/low profits of 2008 drop out of the calculation fairly soon. I read it on the Internet somewhere, so it must be true!

    Great piece. Been listening to a few podcasts with jlcollinsrecently, and they are all excellent.

    1. I seem to have read that, too, Stuart. 😉

      Regardless, the Shiller PE, and the regular PE ratio for that matter are poor predictors of what Mr. Market will do:
      http://awealthofcommonsense.com/2017/12/stock-market-valuations-wont-predict-the-next-crash/

      But then nothing is a good predictor.

      Glad you’ve enjoyed the podcasts. They are fun to do!

  8. I fully subscribe to many of the themes you discuss in your articles and have been investing what I can for the past 10 years in equity trackers and some specific stocks. However I’m currently struggling with what to do with a lump sum of money I recently came into. With stock markets at very high valuations I’m reluctant to pull the trigger and invest when every instinct I have tells me valuations are unsustainable. However the opportunity cost of not investing and holding onto cash is almost as painful. Any thoughts would be welcome.

  9. Be good for you to read these

  10. Survivor · · Reply

    It’s so weird & exciting at the same time to be living in a version of the tulip craze bubble, like resurrecting something from a history book & knowing how it actually felt -so even better than watching Jurassic Park for the first time because its real.

    I sat it out because I just couldn’t understand it, but still wondered if I blew an opportunity when some of my friends who aren’t stupid cracked & had a small punt just to exorcise the feeling of having missed out.

    So it was a relief to see Warren Buffet & MMM [who actually eventually made it to a Guardian article as a result !] come out strongly against all crypto-currencies….. especially as I’d already advised a few close people [who know I’m an amateur investor] to avoid it like the plague.

  11. The Rhino · · Reply

    The thing with being heavy on equities is that it assumes you can choose when you want to spend. Its one thing not panic selling when markets fall, but its another to have other pressing reasons to buy big ticket items during bear markets.

    In the accumulation phase, its buying houses that causes the problem

    In the decumulation phase, its sequence of return risk that causes the problem

    You can’t (or possibly more accurately don’t want to) choose when to buy a house based on the S&P500 and likewise for when you choose to retire. This is where pragmatism kicks in and you diversify away from 100% equities with other hopefully negatively correlated stuff, even though you know it will knock your average long term returns.

    I get where you’re coming from but I think that equity-heavy approach makes more sense when you have a good deal more assets than you need to meet your expenses, i.e. you are better placed to weather storms and therefore take the additional risk. For those cutting it a bit finer for whatever reason – I think its potentially safer to diversify across asset classes?

    I am dearly hoping for a house price crash, ideally due to rising interest rates. The icing on the cake would for it not be accompanied by a stock market crash. Fingers crossed!

    1. Thanks for your comment. You can read Jim’s thoughts on asset allocation here:

      http://jlcollinsnh.com/2014/06/10/stocks-part-xxiii-selecting-your-asset-allocation/

      ps I have edited your comment to remove some inaccuracies.

  12. donaldtramp1 · · Reply

    I totally agree with the article about long term steady investing and holding your nerve but……I’m in the same position as a previous poster Mathew. I also have a considerable sum to invest just now and valuations are sky high. Getting below inflation returns from savings account but i just can’t bring myself to put the lump sum into the stockmarket with current valuations. I know this is a nice problem to have but i really dont know what to do. Any thoughts anyone?

    1. How about drip feed investing instead of lump sum?

      1. Kid Cocoa · ·

        I’d second the monthly drip feeding approach, although NOT with Fidelity, who frustratingly have recently put up their dealing charges and effectively put two fingers up to the smaller investors. For a £50 monthly investment they previously charged just 4 pence, now it is £1.50.
        I’d consider Baillie Gifford and Vanguard as good value options, both of whom offer a good range of investments.

        Start off with nominal amounts for now, and then gear up if/when the crash occurs.

    2. Hi Donald…

      If you’d like my take, check out my reply to Matthew and the two suggested posts.

      1. Thanks for the links Jl. Big fan of your blog. US 33x earnings is a scary high figure though… You’d struggle to sell many many companies on values like that! I know, I know it’s the fear! It’s always there. I’ve had this cash for a while now so I know I’ve already lost a chunk of change.

  13. The Rhino · · Reply

    yes – diversify, certainly across asset classes, but possibly over time as well?

  14. ladyaurora · · Reply

    if it was me id invest ‘some’ of the money over a year. This bull market could continue for a while longer, some folk think were about one third in a secular bull market . no one really knows thats why id invest ‘some’ if it was me.

  15. So much wisdom in one post. Do need to bookmark and indeed read again during the next crash 😉

  16. Regards property you have to also factor in rental income, and if the property is leveraged (ie you have a mortgage on it) then you have to factor in that the amount you actually have invested in the property is a lot lower than the headline figure (which means your returns are potentially higher).

    I have a rental property and in 2017 it increased in value (according to Zoopla) from £233k to £246k, a 5.6% increase (if my maths serves me correctly). I also made about £13k income from it, after all bills were taken off, so about 5.4% if you take the average house value for the year (about £239.5k). So that would be about an 11% return if I had no mortgage.

    But here’s the thing, I have a mortgage of £98k on the property and paid about £3k in interest on that. Which means that my equity in the house (the amount I actually have invested) went from £135k to £148k, a 9.6% increase. My income, after all bills and mortgage interest is taken off would have been about £10k (£13k minus £3k interest), or 7% if you take the average house equity for the year (about £141.5k). Or put it this way, I made £23k on a £135k investment which is a 17% return.

    I realise that it’s not going to be like that across the country, and perhaps you might argue I was lucky. I do think that London property prices (and some surrounding areas) were in bubble territory, especially when considering the average wage in those areas, and it’s probably good that we’re seeing a slow correction. But that is skewing the figures overall as elsewhere in the UK property prices are still increasing quite quickly (I live elsewhere).

    There’s obviously a lot of ‘ifs’ and ‘buts’ here but I don’t think property as an asset class should be dismissed. Anyhow, we’ll see what happens in 2018!

    1. The Rhino · · Reply

      That is a solid return and it looks like you’re getting rich quickly with your current approach. For sure, there has been nothing to touch geared up property investment in the UK for the past 20 years, especially in London. Question remains what does the future hold..

      1. Thanks, my set up is actually a little more complicated because I have debt (and interest) to pay to my parents. Which means my actual investment is lower but conversely it means my return on investment (as a percentage) is even higher, over 20%.

        It is obviously much more risky, I could in theory be wiped out, though house prices are more sticky than stock prices as TEA points out so I’m not too worried. I really just wanted to provide the alternative view regarding property as an asset class.

    2. @wephway – A well articulated, good point. To add to that, this being the UK, property values are culturally sacrosanct & this culture means that even if it’s harming us at the same time, people have been conditioned to defend it whatever may come.

      Given that brainwashing, it’s politically toxic to let property values crash, so there’s an understanding between the electorate & the ruling elite that the state will backstop them to put a floor under any correction. It’s not fair, but so’s life in general.

      As such, specific to the UK [among a handful of states] property/land as an asset class has to at least rival govt. bonds as relatively safe. Added to this though are the tax advantages & leverage via debt of mortgages in general [& even now BTL in particular] for investors to consider – listen to the dogwhistling to follow the money …..

      1. The Rhino · ·

        I’ll be interested to see if millenials defend house prices whatever may come as they filter into government/politics and become more of a force in the voting stakes?

      2. Fatbritabroad · ·

        This is so true I had this conversation at work that I’d considered selling my house. If I did I’d have over 200k which invested could pay a decent amount of rent thus effectively leaving me free rent off the dividend income and leaving me more spare cash to invest and become financially independent. The looks and comments I got from most of my work colleagues made it clear they thought I was mad but looking g at purely as an investment it seems quite sensible to me

  17. ladyaurora · · Reply

    Another way of looking at a stock market crash is as if the stock market it a tree/bush , as it grows and gets bigger eventually it gets distorted and way out of shape,with branches shooting off on their own here and there. Then you come along with hedge cutters [ a stock market crash] and cut it right back again, the more you cut it back the better and more healthy it will grow again , even little snippets off will make a difference but sometime after new fresh growth appears and the tree/bush grows back full and stronger again and bigger and better than before.

  18. I like your posts. The best bit is that they are demystifying investing and I love your tongue in cheek tone. Thank you for writing and sharing.

  19. Harry Jenkins · · Reply

    I’m just starting out and have around £30k lump sum to invest – currently spread out across lots of savings accounts getting around 3% – just waiting for the next crash to happen before sticking it in index’s. However i’m getting a bit impatient and not sure if i should be capitalising on the current bull market (obviously not knowing how long it will last – months, years etc) before the crash eventually comes? What do we reckon?

    1. Lady Aurora · · Reply

      If it was me id get it in the market ..asap .you could wait a long time for a crash. Some think we are in early stages of a secular bull and could have 9 more years of good returns that might be true .also it might not and next week it could crash dramatically. Your trying to time the market and you cannot.

      1. AAJ - clueless investor - · ·

        The only thing I know, is that we are 1 day nearer to the crash. What I would like to know is what are people’s plan in the event of a crash? Do people plan ahead, keep some cash? Or do people carry on as normal?

  20. ladyaurora · · Reply

    Plan ahead mentally. If in drawdown then from what ive learnt live off bonds /cash part of portfolio until market recovers. If in accumaltion buy more equitites.
    I suppose we wont know how it feels till i happens. Dont be over exposed to equities if you think youll buckle. Sites like these will help im sure as we can encourage one another to stay the course.

  21. Very valid points here thanks!
    Come over and share money ideas@
    http://sharemoneyideas.wordpress.com

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