I think we are in a gigantic stock bubble.  I thought we were in a bubble in 2019 and 2020.  Now it is just ridiculous.

As Keynes supposedly said, “The market can remain irrational longer than you can remain solvent.” It was one of the wiser things that he said.

So I’m not telling anyone to short the market or short any particular stocks.  I am not telling anyone not to either. Shorting involves a high degree of speculation because of the issue of timing.  If you shorted the market in 2019 or 2020, it was too early. It may still be too early in April 2021.  We just don’t know.

But unless the Fed goes into some form of hyperinflation, then I believe a dramatic decline in stocks is nearly a sure thing.  It is just a question of when and how much.  It is also a question of how long it lasts, given the Fed’s penchant to try to bail everything out as soon as something happens.

The Fed’s balance sheet continues to go higher. It is near $7.7 trillion now. For context, it was just under $4 trillion in September 2019.  The big explosion happened in March, April and May of 2020.

At some point, something has to give.  I sound like a broken record repeating this, but I can’t emphasize it enough. We are either going to see massive price inflation or we are going to see a major recession, which will likely include a stock market crash.  Maybe we’ll see both.

I believe that price inflation is already a factor.  I believe it is probably beyond the 2% goal stated by the Fed, which the Fed now wants as an average.  It doesn’t say over what time period though.  I think for the basic necessities of life (housing, food, medical care), price inflation is already well exceeding 2% per annum.

Where it Counts

There is a major disconnect between the stock market and people’s actual living standards. This is one reason it should be apparent that stocks are in a bubble.

I know that people are enjoying their “free” government money, with unemployment checks and stimulus checks, but tens of millions of people are struggling right now, even with the government money.

Of course, this “free” money is not free.  The government is spending it by continuing to issue more debt. Most of the debt is being monetized.  In other words, the central bank is creating money out of thin air to pay for it.  This causes resources to be misallocated, and it causes prices to be higher than they otherwise would have been.

I think it is important to look at the stock market for a few reasons.  First, if there is a crash, it is going to mean that the whole economy goes down with it.  In a way, this could be seen as a positive, as it would liquidate malinvestment, increase savings, and clear the way for new prosperity.  There is a good reason it is called a correction.

The problem is that we have to worry about the reactions from the Fed and the government. Just as in 2008/ 2009, they do not allow the full correction to take place.  Instead, they pile onto the problems by trying to temporarily hide them through monetary inflation and massive spending.

The other major reason to look closely at the stock market is for your own personal protection. Most people who have any significant savings have money in the financial markets.  This is especially true of stocks.  Most people who have 401k plans and other retirement plans have some exposure to the stock market.

If you have significant exposure to stocks, then you should be taking steps to reduce that exposure if you haven’t already.  It is bad enough when a recession hits.  Many people are facing unemployment or reduced wages or increased hours.  It makes it that much harder if you watch your net worth get cut in half because you were heavy in stocks.

The other day, I heard a segment with J.L. Collins.  He is a big figure in the financial independence/ retire early (FIRE) community.  He has a lot of good advice.  The one major area where I disagree with him is that he preaches buying and holding index funds. In other words, he generally suggests someone with a somewhat-long time horizon invest heavily in stocks. He might even suggest a good portion in stocks for those who don’t necessarily have a long time horizon.

I heard much praise being heaped on J.L. Collins for his work and his advice.  Of course, he looks like a genius right now because we have had an unprecedented bull market in stocks.  I have to wonder how much praise would be going his way if U.S. stocks looked more like Japan, which has essentially had a bear market for over 3 decades.

If you had invested in the Japanese stock market in 1989, you would still be way down now, over 30 years later.  Would you consider 30 years to be a long enough time horizon for investing?  Are you supposed to wait 50 years for positive returns?

https://en.wikipedia.org/wiki/Nikkei_225#/media/File:Nikkei_225(1970-).svg

What if we are Japan in 1989?  What if U.S. stocks take a massive haircut of 50% or more?  Worse, what if they stay down for a decade or more?  How would that impact your plans for the future?

In the FIRE community, there are tens of thousands of people who take the advice of J.L. Collins and others like him to heart.  What if they are buying index funds now while it is like buying Japanese stock funds in 1989?

Many of these people have been experiencing 25 or 30 percent annual gains over the last few years. They will admit that they are extraordinary, but most of them still expect something around 8% in the long run from here on out.  They say that stocks always go up in the long run.  What if they’re wrong?

What if stocks go down by just 30% and stay there for a decade?  In other words, they perform better than Japan from 1989 to now.  That would still be quite devastating for a lot of people.  It would certainly disrupt a lot of plans for people who plan to retire early (or retire at all) and live financial independence by traveling and sitting on the beach somewhere without having to work.

The stock bubble is not your number one priority.  Your health is more important.  Your income is more important, which is hopefully not too reliant on stocks.

But if stocks make up a significant portion of your portfolio, you may want to ask yourself if you would be able to live with a scenario of a dramatic drop without having a return to these levels for decades.  If that scares you in any way, then you should remedy the situation by getting out of stocks.

I am not predicting a Japan-like scenario for U.S. stocks.  I actually think higher price inflation is more likely in the longer run.  But I can’t discount the possibility either.

Buying stock index funds is not diversification.  It is just diversification between different stocks.  But if the whole stock market is in a gigantic bubble, most of the stocks are going to fall in tandem.  You should prepare accordingly.

I believe that some of the people in the FIRE movement are going to lose credibility if and when stocks implode.  I believe most of these people have many great things to offer in terms of advice.  I just don’t think going mostly all-in on stocks is one of them.