THE PAST FEW WEEKS have brought back memories of the 2008 financial crisis. Back then, stocks were at bargain prices, but I had little money to invest. Today, my financial house is much stronger—and I want to be ready to buy if stocks get dirt cheap.
I’ve already made some portfolio adjustments. But from here, my plan is to keep an eye on stock market valuations. A large percentage drop by the market averages might—by itself—create the false impression that stocks are cheap, so instead I prefer to watch valuation measures such as the market’s price-earnings multiple, price-to-book value and dividend yield.
What are these metrics saying? Despite a 27% drop from its peak, the S&P 500 isn’t exactly cheap. For instance, the cyclically adjusted P/E ratio, or CAPE, is still above its historical average by a large margin. Most other valuation measures paint a similar picture. At these levels, the odds of superior market returns are still low.
I’ve decided to wait to overweight stocks, at least until valuations are closer to normal. I’d put a normal valuation for the S&P 500 at around 1800—a 47% drop from the Feb. 19 all-time high. That size drop has happened just five times, including two occasions since 2000. That’s when I’ll start shifting my asset allocation to overweight stocks. Until then, I’m fine with dollar-cost averaging my ongoing savings into my current asset allocation.
Meanwhile, I’d consider stocks dirt cheap if valuations fall 25% below their historical averages. That would require a whopping 60% drop from the peak, taking the S&P 500 well below 1400. A drop of that magnitude, which would motivate me to bet big, hasn’t happened since the Great Depression. Even at the depth of the 2007-09 bear market, the fall was smaller.
Think I’m daydreaming? Perhaps. The stock market has rallied over the past two days, so maybe I won’t get the chance to load up on stocks that I’m hoping for.
Still, I need a plan if the black swan presents a rare opportunity. For starters, how do I get the money to invest? According to my written asset allocation, I’m already fully invested in the stock market. A normal rebalancing will have limited effect. I need a different plan, one that involves taking more risk.
When I was planning my early retirement a few years ago, I played it safe. I leaned on bonds more than I normally would. If this bear market became a great buying opportunity, I would rethink that choice.
I need bonds for two reasons: to provide diversification and to cover my essential expenses for a decade. I want to keep that 10 years of bare-minimum spending money to weather a prolonged market downturn. As long as I have that cushion, I figure I can invest the rest of my bond-market money in stocks, assuming compelling valuations present themselves.
Next, I may turn to an unloved part of my portfolio: gold. In a halfhearted move, I’d put 5% of my assets in gold. Lately, it’s proven its worth as a safe haven. But I’m dubious about gold’s long-term investment merits. If the right time comes, I won’t hesitate to switch to something more promising: stocks at bargain prices.
My last resort is what I call the nuclear option: tapping the home equity line of credit, or HELOC, on my primary residence. I paid off my mortgage early and have stayed debt-free ever since. But I still have a HELOC as a backup source of emergency money. It cost little to set up and I never thought about using it—until now.
I consider myself risk averse. But if the market got cheap enough, I might use the HELOC to buy stocks. I’m not committed to this plan. But it’s a possibility.
A software engineer by profession, Sanjib Saha is transitioning to early retirement. His previous articles include Spring Cleaning, Working the Plans and Got Gold. Self-taught in investments, Sanjib passed the Series 65 licensing exam as a non-industry candidate. He’s passionate about raising financial literacy and enjoys helping others with their finances.