The post–financial crisis bull market recently became the longest in history, and the S&P 500 continues to reach new all-time highs. In addition, several key metrics indicate that stocks are historically expensive right now.
While it's never a smart idea to stop investing in stocks altogether just because they seem expensive, there are steps you can take to prepare for an eventual downturn. Here's an overview of how this bull market stacks up to others, why the market looks a bit expensive, and what you can do to set yourself up for success, no matter what comes next.
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Is this really the longest bull market in history?
By most experts' definitions, the current bull market is indeed the longest in U.S. history. However, there are two big caveats to that statement. First, as you can see in this chart of the five longest bull markets ever, while this one is the longest, it isn't the one with the largest upside move. Not yet, anyway.
Additionally, some reputable sources consider the bull market that began in the 1990s to be just one part of the longest bull market in history. For example, according to FINRA's list of the five top bull markets, the longest bull market spanned more than 22 years from October 1987 through March 2000. While it was punctuated by some pretty big drops -- the savings and loan crisis in the late 1980s and the dot-com bust in the early 2000s -- there's a solid case to be made that these events were corrections in a longer-term bull market.
Technical definitions aside, there's no denying that the current bull market has been an impressive run for stocks, with the S&P 500 more than quadrupling since the financial crisis lows.
Is the stock market too expensive?
Generally speaking, the answer is yes.
For starters, the average P/E multiple of the S&P 500 is more than 25. This is significantly higher than the long-term average of about 15.7. However, earnings growth has accelerated recently due to tax reform, so it's possible that this metric is deceptively high.
In addition, the so-called Buffett indicator has never been higher. Warren Buffett has described the ratio of total stock market capitalization to GDP as the "best single metric of where valuations stand at any given moment." Generally speaking, levels over 100% are considered to be expensive.
Well, the ratio is currently at more than 148%. Not only is this well beyond what Buffett and many other experts consider to be expensive, but it's at an all-time high. In fact, the indicator peaked at about 145% at the height of the dot-com bubble.
When will it end?
Here's the problem. Stocks are historically expensive right now, and it's difficult to make a solid argument to the contrary. However, timing the market is impossible to do.
In other words, just because we're now in the longest bull market in history doesn't mean that stocks can't continue to go up for several more years. Under the right political and economic circumstances, it's possible that there's tremendous upside from here.
What should you do?
To be clear, it's not wise to stop investing in stocks simply because the market looks expensive. However, there are a few smart moves you can make to protect yourself in the event of a correction while also setting yourself up to take advantage if prices continue to climb higher. For example, you could:
- Start buying some defensive stocks -- utilities, REITs, consumer staples, and Dividend Aristocrats are some good places to look. These tend to fare better than most other stocks during tough times.
- Average into new positions. In other words, instead of investing, say, $5,000 in a stock you have your eye on, it could be smart to invest $1,000 per month. This way, if the market continues to rise, you'll likely enjoy some upside, but if the stock falls, you'll be able to buy some of your shares cheaper.
- Accumulate some cash to take advantage of opportunities that arise if the market corrects. To be clear, it's still a smart idea to leave most of your money invested. As a personal example, I have roughly 10% of my portfolio in cash right now, ready to pounce if stocks drop -- but 90% of my money is still invested and ready to capture any further upside. As Warren Buffett says, "When it rains gold, put out the bucket, not the thimble." Having a modest amount of cash gives you a bucket to put out.
The bottom line is that while stocks look a little expensive right now, there's no reason to think that a downturn is imminent. The bull market won't last forever, but it could certainly last for a while longer. Having said that, it's not a bad idea to play a little defense with your investment strategy.
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