In 2021, I’m increasingly certain that US stocks — particularly those of US tech companies — are in the later stages of a gargantuan bubble. And because all bubbles burst, I think the coming stock market crash is inevitable.
Stock market crash: when reality bites
Since 2009, US investors have enjoyed the longest bull market in history. The S&P 500 has climbed in nine of 12 years, with yearly gains ranging from 9.5% in 2016 to 29.6% in 2013. The three losing years were very modest: 2011 (-0.0%), 2015 (-0.7%) and 2018 (-6.2%). Since the end of 2008, the S&P 500 has more than quintupled, rising 416% before dividends. To me, this points to a bubble primed for a full-blown stock market crash. Yet I feel that so many investors have lost touch with reality, especially Tesla fans. 2020 saw the steepest US economic downturn on record. In the second quarter, output collapsed by almost a third (32.9%), even worse than during the Great Depression. Yet the S&P 500 surged by almost a sixth (16.3%) in 2020. Uh oh.
An ‘epic bubble’
Two factors have blown the biggest bubble in history. First, ultra-low interest rates make future cash flows more valuable today. Second, low inflation pushes up real returns. But for a stock market crash to be avoided, these ideal conditions have to continue in perpetuity. That simply isn’t going to happen.
Other market veterans also think this way. Jeremy Grantham of GMO published this in early 2021: Waiting for the Last Dance. Grantham warned that we are in “an epic bubble”. He sees, “extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behaviour.” Grantham believes that the next stock market crash will be “right along with the South Sea bubble, 1929, and 2000.”
I wasn’t around in 1720 and 1929, but I clearly recall the stock market crashes of 1987, 2000-03 and 2007-09. I also witnessed Japan’s late-1980s bubble and last year’s March meltdown. For me, the 1990s and noughties bubbles had this in common: fanatical extremism. Investors fervently believed in a ‘new paradigm’ and that ‘this time is different’. They had to, since this belief was the only thing justifying ridiculously high prices. When financial gravity finally prevailed, prices duly collapsed and bubble fortunes were spectacularly lost.
I’m de-risking my portfolio
Today, I see the same crazy cultism and fanatical behaviour as in other great bubbles. Alas, human psychology — especially fear and greed — never changes. That’s why I expect this bubble to keep inflating in 2021 before a full-on stock market crash by mid-2022 at the very latest. Right now, I’m terrified, because I can smell smoke. And rather than wait for the whole house to burn down, I’m plan to watch from a safe distance.
To be clear, I’m not selling up and going 100% into cash (although my family portfolio was 50% in cash before the 2020 March meltdown). Instead, I’m going to radically reduce our exposure to frothy US stocks, where we’ve enjoyed bumper gains since 2016. With the proceeds, I will buy more reasonably priced assets, including FTSE 100 value shares. Also, I’m going to cushion the crash’s impact by buying plenty of high-yielding UK dividend shares. The high income from these boring, safe holdings will help to offset declines elsewhere. Furthermore, with emerging-market stocks looking historically cheap, some capital will go into this sector. Right now, I’m all about reducing risk, volatility and portfolio pain — and being boring before the next crash inescapably arrives in 2021/22!
Cliffdarcy has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Tesla. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.