The Stock Market Just Peaked

What's up, Graham? It's guys here. So, between record high inflation, imminent rate hikes, and outsized earnings, there's no denying that there's a lot of uncertainty and opposing viewpoints in the market right now.

On the one side, we have some of the most renowned investors warning us about a heightened chance of everything falling into a bear market. Well, the other side assures us that the worst is over, everything is fine, and the prices are headed towards even higher highs. So, who's right?

Well, in order to answer that and to analyze exactly how and when the next stock market crash will happen, it's important to look at both sides, talk about the latest events taking place, and then we could determine which scenario has a higher likelihood of happening: a 20% drop or going to the moon and printing even more tendies.

Now, this is not to say that we're 100% about to see a stock market crash or a price surge in the next few weeks, but it is about making sure that you think about the current state of the market and that you're invested in such a way that you don't lose everything.

But before we talk about that, I want to say a huge thank you to the sponsor of today's video: the like button. For the cost of absolute free, with one gentle tap, you'll be rewarded with endless free content that helps the YouTube algorithm. And as a special bonus, if you hit the like button in the next five seconds, I'll show you this really cute picture of a baby clownfish. So thank you guys so much!

Now, with that said, let's begin. To start, let's get some of the bad news out of the way, and that means we should first talk about why the stock market could soon begin to decline.

First, the Federal Reserve is ending their $120 billion a month bond buying in March, which, at this point, is only a few weeks away. See, throughout the pandemic and up until January, the Federal Reserve was purchasing $120 billion a month of treasuries and mortgage-backed securities as a way to ensure that whoever needed money got money. But that was only meant to be temporary, and recently the entire market started to panic at the thought that the Fed would reduce those purchases faster than expected, and as a result, the market sold off.

However, as of about two weeks ago, the Fed confirmed that they would be reducing their stimulus by $30 billion a month until, by the end of March, they're completely done and don't need to buy anything else. Although there's still very much this looming uncertainty of what happens when they stop buying bonds entirely.

Well, that term is what's known as a taper tantrum. The last time this happened was in 2013 when the Fed announced that they would reduce their mortgage buying after the Great Financial Crisis, and as a result, investors went into a full-scale panic. Interest rates spiked out of nowhere, volatility went crazy, emerging markets tumbled, and now there's the worry that that could happen again.

Truthfully, we don't know the full extent as to what a lack of bond and mortgage buying will do to the markets or if that causes rates to rise, which dampens growth and subsequently lowers prices. But that does make way for a second argument, and that would be rising interest rates.

Here's the thing: throughout the last 50 years, interest rates have done nothing but trend lower and lower and lower until recently, they hit zero percent, where essentially you could borrow money for free, just as a way to get people to spend. In fact, during the pandemic, rates were dropped to the lowest level ever in history, and when they're already at rock bottom, there's very much the consensus that there's nowhere else to go but up.

But with all of that, there is a slight problem. When interest rates are zero and inflation is high, the only place that people are able to get a meaningful return on their money is stocks and real estate, thereby causing their values to increase. But when interest rates rise, and all of a sudden investors have the opportunity to earn 2% in a savings account, 4% in a treasury bill, or 5% in a low-risk bond, there's less of a need to invest in growth companies on their future earnings.

As a result, the price of those stocks tends to go down. In fact, as we could see over time, as rates rise, a large portion of the market begins to sell off, and with tech stocks having seen a meteoric rise over the last two years, they'll tend to suffer a little bit faster than everything else.

Third, markets could very well be overvalued. See, one of the most common ways that people apply evaluation to the stock market is what's known as a price-to-earnings ratio. This is calculated by dividing the company's stock price with its most recently reported earnings, and the lower the number, the more undervalued it tends to be.

However, what's unique about today is that the P/E ratio of the market is the third highest it's ever been in history. As you can see, the last two times it's been this high, we've had the Great Depression and the 2001 dot-com bubble. Today, this P/E ratio is largely held up by some of the largest companies who have benefited from low rates and excess online demand.

We can also see that when adjusting for inflation, the market is trading near the upper range of its long-term trend, and when you look at the overall return, it's also holding near its all-time high. Forbes recently detailed their analysis, suggesting that loose monetary policy combined with low interest rates have caused stock prices to soar. When you combine that with stimulus and record high inflation, it's a perfect catalyst for what we're seeing today.

The issue, they believe, is that unless earnings growth continues to break records, stocks won't see a continued push higher, and as a result, they could begin to fall. On top of that, 93 S&P 500 companies have issued earnings guidance for the fourth quarter. Of those companies, 56 released negative earnings guidance, and 37 had disclosed positive earnings guidance. That means more S&P 500 companies are issuing negative guidance over positive guidance for the first time since the second quarter of 2020.

And the ultimate whammy: we have the Buffett indicator suggesting that the market value is 59% higher than the historic average compared to GDP. At the same time, the fear and greed index is moving towards fear. I mean, even NASDAQ said that there was a 70% chance of a base case coming soon where stocks just flatline.

But those are just the bear cases, and to have an even argument, we have to talk about the other side, because maybe stocks could continue going even higher.

First, corporate profits are still quite strong. The fact is, even though people are slightly more cautious, there's still a lot of pent-up demand that's bolstering prices even higher. And we've seen that firsthand throughout this last week. Companies like Nvidia, AMD, Chipotle, Lyft, and Microsoft, among a multitude of other large companies, have all reported strong earnings and a positive outlook, even despite inflation concerns.

This leads people to believe that valuations could be sustained because there's no shortage of people continuing to buy. On top of that, second, unemployment is extremely low. As of today, we're nearing an all-time record low unemployment rate, just barely above where it was prior to the pandemic and lower than any other time since the 1960s.

There's also so much demand for skilled labor that there's a shortage of workers. Companies scramble to pay anything they can to get people on board. Home Depot is even offering what they call next-day job offers for people who apply and want to start immediately. Much of this was caused by the Great Resignation, as people quit their jobs to retire early, work from home, or simply find a job with better work-life balance.

That left plenty of open positions for people to fill, and they did so. With the strong labor market combined with strong earnings, there's no shortage of people continuing to bolster up the prices even more.

Third, we have an interesting argument from Tina—no, not that Tina, this Tina. The acronym refers to an asset allocation that's less ideal because there is no alternative. Like in this case, if you want to make a return, where do you put your money?

With a savings account and cash, you lose money to inflation. With bonds, they pay absolutely nothing. With gold, it's underperformed over the last few decades. So the thinking is that people are going to keep buying stocks and real estate because what else is there to buy?

Of course, over the long term, being a good investor isn't just about maximizing returns but also being able to withstand a downturn long enough to see it through. However, in this case, Tina gives us the reality that if you want to grow your money, stocks have historically been the best way to do that, and that is very likely to continue, especially with bond rates continuing to decline.

But then we got fourth: rising interest rates might not be so bad. Yes, it is true that rising rates do tend to depress the market, but it's not necessarily all bad for all stocks. In fact, historically, rising rates have actually been pretty good for banks, energy, the automotive industry, and transportation.

In addition, since 1994, it was found that the first interest rate hike actually led stocks to increase an average of 7.3% in the following 12 months. The reason for this is that generally, rates only increase in a growing, healthy economy that could handle a higher rate increase. So, in a way, the stock market would benefit from that type of optimism.

On top of that, the long-term trend of rate increases is such that every single rate increase has been unable to reach the level of the one before it, suggesting that we're very unlikely to see a rate increase that the market couldn't already handle. There's also always the chance that during the next recession, rates could go negative, as they have in other countries like Switzerland at negative 0.75%, then market negative half a percent in Japan and negative 0.1% in both Sweden and Spain at zero percent.

Even though it seems kind of far-fetched, it wouldn't exactly be impossible. So the moral of the story here is: don't fight the Fed.

And fourth, supply chains are beginning to normalize. Inflation is beginning to stabilize, and then we could be left with an economy with low unemployment and strong demand, thereby pushing prices to the moon. After all, in terms of inflation, the Fed believes that prices will begin to come down throughout the next year, pushing inflation to 2.3% in 2023 and back down to 2.1% in 2024.

On top of that, the Wealth of Common Sense blog broke down the years of highest inflation since the 1940s, and he found that during the highest years of inflation, stocks actually wound up increasing by an average of 9.4%, proving that rising prices aren't always correlated with negative stock market returns. Same thing goes for supply chains.

JP Morgan recently surveyed 1,600 executives across the country and found that 83% have a positive outlook over the next 12 months. It was even noted that when you look at the amount of time it takes for manufacturers to get their hands on raw materials, the supply chain delivery times are starting to shrink again.

In terms of the numbers, though, container shipping costs from China to the U.S. West Coast have retreated 30% from their fall peaks, and the number of containers sitting idle at the Port of Los Angeles is down 40% since early November, suggesting, of course, that the situation is only getting better.

So, in terms of what you could do about this, regardless of what happens, look no further than one of my favorite blogs, Market Sentiment, who researches various investment strategies and decides whether or not it's worth your time and money. A link to the full article down below in the description for anybody who wants to follow along.

But he highlights that there's a problem when it comes to investing in that there's not a one-size-fits-all approach. All of us have different expectations, different risk tolerances, and different goals, so what might work for you might not work for somebody else.

That's why it's broken down investing into a few main categories. First, we got spine chill. This is the belief that the largest U.S. companies will continue to do well, and so far, historically, they have, to the tune of 12.3% a year. However, since you're 100% invested in stocks, weighted heavily towards tech, during a downturn, you could see a decline of 40% or more, like we had in 2008. So this is something to be made aware of.

The second, we got a 50/50 mix of stocks and bonds. The theory behind this is that stocks should go up when the market does well, and when the market drops, bonds should hold their values. So either way, you win, right? Well, even though you would have earned slightly less with a 10% return over 19 years, you also would have only experienced a maximum of a 14% decline during the worst months, essentially making this a hedge against a bear market.

The third: you could diversify. This example gave us a one-third equal split between small, mid, and large-cap stocks, and that returned 12.5% annually. This gives you a little bit less risk, but it's also balanced off by a slightly lower return.

Now, if you're not having that, you could do fourth: all in tech. Now, this in hindsight did the best throughout the last 20 years, with a return of 17.5% annually. But when times get tough, this portfolio is prone to the largest decline at a 78% loss during the previous dot-com bubble, and there's no guarantee that this type of explosive growth will continue.

And finally, speaking of growth, we have number five: growth. This was associated with the top five companies by market cap, including Amazon, Apple, Google, Tesla, and Microsoft, and surprisingly, it gave a better risk-adjusted return when compared to the S&P 500 at a whopping 15.4%.

The moral of the story here is that regardless of what happens with the market, it's really important that you have a strategy that you stick with ahead of time. Because eventually, there will be a drop. There will be another sort of crazy crash, and it's really up to you to make sure you're in the best position possible to stick through it, make the most profit possible, and hit the like button for the YouTube algorithm if you haven't done that already.

So thank you guys so much for watching. Also, make sure to add me on Instagram and to my second channel, The Graham Stephan Show. I post there every single day when I'm not posting here. So if you want to see a brand new video from me every single day, make sure to add yourself to that. Thank you so much for watching, and until next time!