Key Points
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The market has been shaky, and investors are divided over what the next few months may look like.
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One market metric is repeating a pattern seen only during the dot-com bubble two decades ago.
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The safest investment strategy right now involves just two simple steps.
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After years of record-breaking growth, major market indexes have stagnated. The S&P 500 (SNPINDEX: ^GSPC) and the Dow Jones Industrial Average (DJINDICES: ^DJI) have each dipped by around 2% from their all-time highs, while the Nasdaq Composite (NASDAQINDEX: ^IXIC) has slipped by close to 6%.
Investors are also feeling conflicted about the future of the market. Nearly 46% of investors believe stock prices will fall over the next six months, according to the latest weekly survey from the American Association of Individual Investors, while 37% are bullish about the future, and the remaining 17% expect little change.
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While it’s impossible to predict how stocks will perform in the coming months, the market is sending a warning signal that has only been seen during the dot-com bubble. Here’s how investors can prepare right now.
Image source: Getty Images.
Is history repeating itself right now?
In the late 1990s, tech stocks were booming as excitement about the internet reached fever pitch. Many tech companies saw record-breaking initial public offerings (IPOs), reaching valuations that were astronomical for the time. Between 1995 and 1999 alone, the S&P 500 soared by close to 200%.
Another metric that was reaching record highs, though, was the S&P 500 Shiller cyclically adjusted price-to-earnings (CAPE) ratio. This ratio measures the S&P 500’s long-term valuation, with higher figures suggesting that the index is overvalued.
Historically, higher ratios have been followed by a drop in stock prices, and this metric has predicted market crashes such as the 1929 Great Depression. In early 1999, the ratio surpassed 40 for the first time in history as the dot-com bubble grew. Just over a year later, in March 2000, the bear market officially began.
Shiller CAPE Ratio data by YCharts
Now the CAPE ratio is elevated again. The metric surpassed 40 in May of this year, where it’s remained ever since. This is only the second time in history that it’s stayed this high for months at a time.
To be clear, this doesn’t necessarily mean we’re headed toward a dot-com-style crash. This metric provides a snapshot of the market’s valuation over time, but it can’t predict when the next bear market will begin, how severe it might be, or how long it might last.
That said, it does suggest that stocks are incredibly richly valued, making this the priciest market in decades.
History says this is the smartest move to make
If a recession or stock market crash is coming, the best move investors can make is to buy quality stocks and hold them for the long term.
Companies with weak foundations will have a harder time rebounding from downturns, and some may not recover at all. Countless tech stocks soared to record valuations in the 1990s, for example, only to go bankrupt just a few years later when the bubble popped. The tech stocks that survived were those with healthy finances, a durable competitive advantage, and capable leadership teams.
Even healthy companies can experience severe short-term volatility, which is why a long-term outlook is key. Microsoft, for example, plunged by 60% during the dot-com bear market. Apple lost more than 51% of its value in a single trading day in 2000. And Amazon sank by a staggering 94% between 1999 and 2001.
AMZN Total Return Level data by YCharts
Now, all of these stocks are industry-leading giants, and the investors who reaped the greatest rewards were those who held on and continued investing even during the bleakest moments.
No two bear markets are identical, but even if history is repeating itself and we’re staring down another market crash, the smartest investors aren’t panicking. Rather, they’re loading up on healthy stocks with robust fundamentals, and they’re giving those investments plenty of time to generate life-changing wealth.
In the wise words of Warren Buffett: “Keep buying it through thick and thin, and especially through thin.”
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Katie Brockman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon, Apple, and Microsoft. The Motley Fool has a disclosure policy.
