How do you know if the stock market is heading to correction?

Here’s the thing…

Stocks have had a pretty good run.

As per many experts We’re due for a market correction any day now.

But will this correction happen any time soon? And can we even predict that?

In what follows I try to answer these questions.

First, Shiller P/E is Above 30

The Nobel prize-winning economist in 2013 Robert Shiller warned that markets can become irrationally exuberant.

The Shiller P/E ratio measures the market’s level of sanity or insanity.

This ratio tracks the cyclically adjusted price of the stock market against its earnings, the normal ratio is 16.

Now it is 38.

Historically, Shiller P/E has only been above 30, three times:

During 1929 the great depression, when it reached 30,
During 1999, the dotcom bubble reached 34.

During 2007 when we witnessed a huge crash.

Second, the whileshire GDP, Warren Buffett Indicator at All-Time High.

Warren Buffett says that the single best measure of where valuations stand is comparing the market cap to GDP.

The Buffett indicator takes the very broad index called Wilshire 5000 and holds it up against GDP.

This indicator usually should be around 50-75.

If it reaches above 90, the market is in bubble area.

It’s not only above 90 it’s around 200.

It has never been that high before.

Maybe it’s not so strange that Warren Buffett holds around 150 billion dollars in cash (or cash equivalent). Think about it!
Third, many economists are talking about the threat of rising inflation. Some even talk about possible hyperinflation.

Federal Reserve historically raised interest rates in order to stop inflation and to slow the economy down. So, what the Fed did in 2009 in order to stimulate full employment was they dropped interest rates kept dropping them and nothing happened.  So, then they stepped in and just printed money, they printed about $4 trillion. Now the way they do that is they just make an entry in the Federal Reserve Bank assets and liabilities they make an entry that says we have $4 trillion, then they took the $4 trillion and they bought treasury bonds with it and that’s how the government got the money.

Then, COVID showed up and all of a sudden they felt the need to print a whole lot of money. They printed $6 trillion over the year 2020 year and then today we’re now continuing to print over and over again,  what follows, increasing in prices of everything, houses, gas, food, and college education. And the inflation looks like inflation is really strong.

I am not sure how they will get out of that but usually the way they get out of it is a massive devaluation of currency and typically a massive recession. That’s the very thing they’ve been trying to avoid for 10 years. Now the other possibility is the Fed will quietly start raising interest rates and that’s what they’ve been saying they’re going to do, and at the moment they do it, the stock market will take a turn. If the US Federal Reserve (the Fed) raises interest rates, it can actually cause a stock market crash.

We have had a taste of this several times in recent years, including in 2018 when the Fed raised interest rates four times in a row. Stock prices began to tremble, the fell sharply in late 2018. This led the Fed to lower rates again out of concern for a stock market crash, and the market calmed.

We have had low inflation and low interest rates for many years.

Why should that change now?

Because a lot of money has been pumped into the economy following the start of the COVID-19 crisis.

The Fed has pumped money into the system at a rate we haven’t seen before, not even during the 2008 financial crisis.

When large amounts of money are pumped into the system, it causes prices to rise. Inflation in the United States has been around 2 percent for many years (on average from about 2000 until recently). This spring we saw a spike. It doubled and measured around 4 percent in May.

Nobody knows how far it can go.

So, What should you do now? What can you do to protect yourself from inflation?

First of all, make sure you’re looking at the big picture… Go back to the history and study the history of corrections. Corrections are normal. Don’t fall victim to losing sight of the big picture. Right now, the data says we are re in the midst of a Melt Up. So, while a correction could be looming, it’s likely nothing to worry about. Just Be careful. Be educated. Stay with high quality companies.

Should You keep Cash? If there is an imminent threat of rising interest rates and falling stock prices, can cash be a solution? In the short term, it’s fine to have cash so you’re able to take advantage and buy shares in the event of a stock market crash, but in the long term, cash is the worst asset group to hold.

Why? Because as we all know, and it is a fact, the value of your money will erode.

If inflation is 4 percent, the value of your money will be halved in 18 years. If it rises to an average of 5 percent, your money will be halved in 14 years. nothing attractive.

Should you buy gold?

The advantage of gold is that the amount of it is limited. This means that it keeps its value over time (and even increases in value).

The problem with gold is that it’s a piece of metal that can’t invent products, employ people, or innovate. It’s not as good an asset as stocks over time.

Warren Buffett in 2018, illustrated the problem with gold at the Berkshire Hathaway annual meeting.

If you had invested $ 10,000 in gold in 1942, then it would have increased to $400,000 in 2018. If you had invested the same amount in the stock market (the Dow Jones index), that amount would have become $ 51 million.

That’s a wild difference, right? A bit of an eye opener.

Why Stocks Are the Best Protection?

When you buy stocks, you are buying a small stake in a company.

Good companies are able to protect themselves against inflation.

How? Inflation means rising prices.

You need to find companies that can let their prices rise with inflation, or even above inflation.

Think about it. If everything rises 4 percent, would you stop buying toothpaste or juice because they also rose 4 percent?

No, right?

Some companies are even better at protecting themselves because their customers aren’t so sensitive to price hikes.

Take Apple’s products, for example.

The average price of an iPhone rose from $ 650 to $ 1,000 in five years.

If you buy iPhone 7 in 2016 I bet you realized that you paid much more than you had previously done for an iPhone 4.

It was more or less double what your previous phone had cost.

But then it wasn’t the same phone at all. It had a better camera, improved features, and a lot more memory.

In 2020, f you bought an iPhone 11 Pro Max, you paid double what you previously paid for the iPhone 7.

But Don’t Invest Blindly in Stocks.

Instead, you need to invest intelligently in stocks. Focusing on few high quality companies after careful valuation.

You need to invest with an eye on how expensive a company is trading on the stock exchange, and you have to make sure that you invest when it’s cheap or reasonably priced. You need to understand that when the market is greedy like it is right now we want to sell things and when it starts to get very fearful which will be the next level of the cycle we want to buy.