Cash In On the Crash
How quickly individual investors forget that stocks go up and down.
The famous Dow Jones Industrial Average stock index hit a new all-time high in early October. A week later, the Dow fell more than 800 points. It fell another 500 points the next day. All in all, we had a nearly 1,400-point decline (or a 5%-plus fall) in just two days.
I get it – that scared folks. But you’ve got to understand something…
Volatility is part of a “Melt Up” in stocks. You can’t have one without the other. You need to expect big ups – and big downs (even bigger than we recently experienced) – in the coming months.
This should make intuitive sense…
After all, a Melt Up is the final blow-off top of a long-term bull market. It’s the glorious, unadulterated boom before the next bust arrives. For this to happen, by definition, prices have to move – a lot.
Here’s another way to think of it…
If a market has the potential to jump 100% in a year, then of course it can fall 10% along the way. That’s simply how Melt Ups work. It’s the nature of what’s going on right now.
Don’t just take my word for it, though… Let me show you.
In the final 12 months of the dot-com boom, the Nasdaq fell by roughly 10% or more – five separate times. Take a look at the chart…
As you can see, the last Melt Up was not a one-way move higher.
And the 10% falls happened quickly – just like the fall we saw last month. They all took place in a month or less. But at the time, they were still painful. At 10%-plus, they each reached the level of a full-blown correction – even worse than the move in early October.
Once investors get used to a one-way market, they forget that stocks go down as well as up.
If you were invested back in 1999, all five of these moves would have made you question whether staying long stocks was the right choice. But today, nobody remembers any of it.
The way most folks talk about the dot-com boom now, you’d think stocks did nothing but soar the entire time…
The Nasdaq more than doubled during the final 12 months of that boom. That’s the part everyone remembers.
The reality is, pullbacks and corrections are normal… even during a blow-off top. And if today’s Melt Up plays out anything like the last great Melt Up, then we could see as many as five corrections – worse than what we just went through – before the market peaks.
So yes, we’ve seen some terrible volatility… And no, you don’t have to like it. But a pullback in stocks does not signal the end of the Melt Up.
We’ve seen some terrible volatility… But a pullback in stocks does not signal the end of the Melt Up.
And it’s not the only big issue that folks seem to have with my Melt Up prediction. They raise another big objection, over and over again…
The Melt Up skeptics say stocks are too expensive. After all, they say, prices have gone up and up for almost 10 years. They believe stocks HAVE to crash from today’s levels… that prices can’t possibly move higher from here.
The funny thing is that folks have had this problem for years. They don’t seem to understand the reality of the situation. Let me explain…
Heck No, Stocks Aren’t Too Expensive to Boom
One of the biggest mistakes of my career was missing out on the last great Melt Up…
At the time, the dot-com boom didn’t make any sense to me. Stocks soared on hype, but the businesses behind them had no real future.
I watched friends get “paper rich” in dot-com stock options. And instead of joining the mania, I stood on the sidelines.
“It can’t go on any longer,” I told myself.
But it did go on longer.
I learned an important lesson from that. And in my career, it’s helped me to stand strong in bull markets around the world over the nearly two decades since the dot-com boom.
It’s one big reason why I’ve stood strong in this bull market.
The lesson has two parts…
Just because stocks are expensive, it doesn’t mean they can’t go much higher.
High valuations are a symptom of a stock market peak… But they are not the cause of a stock market peak.
Let me walk you through my personal experience with this…
By the end of 1994, stocks had gone up for 12 out of the previous 13 years.
Said another way, you would have lost money on stocks during only one calendar year since 1981.
As you might guess, after that 13-year boom in stocks, measures of valuation showed that stocks were getting expensive. Any rational person in 1994 would think stock prices couldn’t go much higher.
But then something irrational happened in 1995. Stocks did go higher… They soared 38%.
That drove valuations to crazy heights…
Stocks had only been THAT expensive two times in history – in 1929, and in the late 1960s. You can see this by looking at the cyclically adjusted price-to-earnings (or CAPE) ratio, one of the most popular ways to measure value in the markets over the long term. Take a look at the chart…
Those two previous peaks were significant – and so were the losses that followed…
The Great Depression followed the 1929 peak. And stocks lost a fortune in the 1970s after the late 1960s peak… shedding nearly half their value from 1973 to 1974, adjusted for inflation.
So in 1994 and 1995, any rational person would have said that valuations were extreme – hitting levels that had preceded the two greatest stock market busts in the 20th century.
Buying then would have seemed foolish…
Except it wasn’t. It was exactly what you should have done.
After soaring 38% in 1995, stocks jumped 23% in 1996.
Astonishingly, that STILL wasn’t the end of it… The market soared another 33% in 1997.
By the end of that year, stocks had become more expensive than at any time in history. Take a look at the top chart…
That was a surely a sell signal – right? Stocks were even more expensive than right before the 1929 peak!
In hindsight, it was not a sell signal. Instead, what happened next shocked all rational people…
Stocks went up – again – in 1998. And once again, it was a BIG gain. The S&P 500 went up 29%. And tech stocks went up even more – the Nasdaq soared 40% in 1998.
This is when the last great Melt Up started.
Investors who had been skeptics got religion. The late 1990s had taught folks not to worry about high valuations. This time was different, right?
Animal spirits kicked in. The excitement was palpable. And things got even crazier…
In the late 1990s, many of my buddies were leaving their “real” jobs and joining dot-com companies. They got stock options for changing jobs. On paper, they were worth more than I could imagine.
And I started to feel like the fool for staying on the sidelines instead of joining them.
Stocks just kept going higher… The Nasdaq soared a ridiculous 86% in 1999.
Take a look at the chart below. What happened to valuations before the boom was finally over. They went up further than any rational person would have thought possible…
If you were smart enough to know that valuations alone don’t kill bull markets… and if you were bold enough to simply stay on board as the stock market “melted up”… then you would have made an absolute fortune.
To be honest with you, I was neither smart enough nor bold enough to do those things…
I personally missed out on most of the upside in the late 1990s. And I missed out on basically all of the upside of the dot-com boom in 1999.
I didn’t believe in it. It didn’t make rational sense. Stocks were record-expensive, and people were acting completely irrationally.
Now, I am older and wiser. (Certainly older… hopefully wiser!)
I have stayed on board today’s bull market longer than any other analyst I know. My experience taught me two important lessons…
Valuations are high today – but not absolutely crazy based on history.
Valuations alone don’t kill bull markets.
Most people say that stocks are near record-high valuations. The CAPE ratio is above 30 today, inching back toward the dot-com boom highs.
But after my 1990s experience, I look at how stocks soared from similar levels back then. And I believe we could see years of gains before we see true Melt Up valuations.
People are not acting completely irrationally – not yet. They’re worried about valuations. They’re worried about interest rates. They’re worried about trade wars.
At some point, they’ll notice that the sky isn’t falling… And they’ll stop worrying. They’ll buy with reckless abandon. Valuations won’t matter one bit. Their only worry will be missing out on the huge gains their friends and family are racking up in the market.
As we saw in 1999, that is the hallmark of a true market top. We’re not there yet… Not even close.
Today, we have high levels of fear and worry. Prices have pulled back… Volatility has picked up… And we are nowhere near the optimism and excitement that signals the top of the market.
That’s why I still urge you to stay long U.S. stocks.
Dr. Steve Sjuggerud holds an MBA and a PhD in finance. He’s worked as a stockbroker, vice president of a global mutual fund, and a hedge-fund manager. His track record has landed him on various television networks including stints on Fox Business News, Bloomberg’s Taking Stock, and CNBC, among others.
