As dark clouds accumulate over the stock market, investors should remember the importance of diversifying their holdings as protection against a potential storm.
By historical standards, stock market valuations are stretched. The Standard & Poor’s 500 Index hit a new all-time high in early October and remained close to the record through mid-month. At a price-earnings multiple of 24, the S&P 500 index is priced well above its historical level of about 18. Another S&P 500 valuation measure, the cyclically adjusted price-to-earnings (CAPE) ratio, which accounts for economic cycles, is above 41, near the record high of 44 reached near the dot-com crash.
A relatively narrow group of large-capitalization technology stocks has been leading the stock market. Meanwhile, market breadth is poor; less than half of S&P 500 stocks are trading above their 200-day moving average.
And the economic fundamentals underlying stocks are not encouraging. Inflation is accelerating rapidly, driven by tariffs and the soaring cost of fuel. Consumers are getting hit at the gas pump and cash register, as companies pass along the higher cost of transporting and manufacturing goods.
Consumer spending is the engine of the American economy. But rising inflation and higher interest rates are depressing consumer sentiment, which has fallen to its second lowest reading in history.
Rising rates also mean higher costs for companies, whether they borrow from banks or by selling debt in the bond market. For firms that are heavily leveraged, the higher cost of money can cause a profit squeeze.
Meanwhile, many investors are holding stock they purchased on margin—with borrowed funds. Their margin debt stands at nearly $1.5 trillion. That amount of leverage could lead to forced selling in a market decline that could dramatically accelerate losses.
These warning signs may or may not trigger a severe stock market selloff; no one can predict precisely when, or if, stocks will plunge. But similar worrying signs of excess in the stock market in the face of economic turmoil also occurred in past Octobers— 1929, 1987, and 2008—all of which saw the stock market crash.
What we do know for certain is that placing some assets in gold, and holding the precious metal for the long-term, is an excellent way to protect one’s investment portfolio, preserve wealth, and ease the pain of the stock market’s inevitable volatility.
