The Dow has soared 13% since Election Day, and just last week (Feb. 10), all three major indexes closed at all-time highs. The "Trump Rally" has been great for stocks, but some observers are starting to wonder if soaring highs mean a stock market crash is coming.
No one can predict a stock market crash with 100% certainty. But we want our readers to be as informed as possible about what could happen in the market.
That's why we're looking into historic stock market crashes to identify warning signs that can be used now.
And we want our readers to know how to protect their money when the next stock market crash happens.
We'll show you how to do just that. Before we get to that, here's what we've learned causes a stock market crash and why you should be prepared now...
This Could Cause a Stock Market Crash in 2017
Speculative investing can lead to a stock market bubble, and a bubble could lead to a 2017 stock market crash.
Speculation means traders are taking too many risks to buy stocks because they believe the market will only go up. Speculative investing can drive markets to all-time highs, but it also means stocks are priced far above their real value. And when the market corrects for this, the whole thing could crash.
Take the most famous stock market crash of all.
The 1929 stock market crash was brought on by nearly a decade of speculation.
During the 1920s, the stock market surged to unheard of highs. Investors even began to believe stocks could only go higher and that they were losing money by not investing.
This mentality led investors to take on irresponsible risks. Between 1923 and 1929, amateur investors borrowed over $120 billion (in today's dollars) to put into stocks.
And the logic made sense at the time. If the stock market was only going up, then there was little to no risk to buying stocks with borrowed money.
But the market highs were not sustainable. Stocks had sailed past their actual value as investors paid any price for them. And when stocks are soaring past their true value, a stock market bubble is inflating.
When the stock market began to correct in September 1929, investors panicked. Speculators couldn't afford any losses, so they sold their stocks immediately. This mass sell-off sent stock prices falling. Between September 1929 and June 1932, the Dow lost 86% of its value. An investor with $10,000 in the market in August 1929 had just $1,400 left by 1932.
This sort of catastrophic fall is the definition of a stock market crash.
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We saw the same pattern more recently. The stock market crash of 2008 was caused by a bubble in the real estate market.
House prices almost doubled between 1996 and 2006. Investors believed prices would always rise and thus investing in real estate was less risky. Banks loaned money to high-risk borrowers, knowing they could sell the mortgage to Wall Street traders.
But the bubble eventually burst. Between 2007 and 2009, average home prices declined by a massive 30%. With house prices falling, many homeowners could no longer refinance their homes and were underwater on their loans.
And the housing collapse led to the 2008 stock market crash.
On Sept. 29, 2008, the Dow plunged 7%, the largest single-day drop in its history. Americans would lose $2 trillion in retirement savings by the end of the financial crisis.
Now we are seeing some of the same signs of speculation inflating stock prices, a sign a stock market crash is coming...
Are We in a Stock Market Bubble?
The major stock market indexes are near all-time highs, but we've found evidence that low interest rates have artificially boosted stock prices.
The U.S. Federal Reserve slashed interest rates from over 5% to 0.25% in 2008. Since then, the Fed has only raised rates twice, and they remain under 1%.
And these historically low interest rates have helped fuel explosive stock market growth.
You see, the Fed cut rates because it wanted corporations to be able to borrow money cheaply. It reasoned that cheap money would let corporations spend on new projects and take more risks, which would grow the economy out of the recession.
Instead, U.S. corporations have been using the cheap money to buy back shares of their own stock. U.S. companies have borrowed $2.1 trillion since 2008, and they've bought back over $1.9 trillion of their own stock in the same period.
This trend of huge share buybacks has helped push stock prices higher than ever. But it's made stocks too high.
The Shiller PE ratio, a measure of stock market value, shows stocks are currently 73% above their historical average. That's higher than stocks were valued before the 2008 financial crisis...
Now the Fed is signaling more interest rate hikes are coming. At the December FOMC meeting, members of the Fed predicted there would be three rate hikes in 2017. And Janet Yellen has been vocal that rate hikes are on the way.
"It's our expectation that rate increases this year would be appropriate," Yellen told Congress on Tuesday (Feb. 14).
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That means cheap money is coming to an end, and overinflated stock prices might be, too. That could lead to a stock market crash in 2017.
But investors need not fear an economic collapse. We want our readers prepared for the worst-case scenario. That's why we've put together a stock market crash investment plan. Here's how to protect your money when a stock market crash is coming...
How to Protect Your Money When the Stock Market Crashes
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There are three parts of our stock market crash protection plan.
First, Money Morning Global Credit Strategist Michael Lewitt advises investors to keep 10% to 20% of their portfolio in gold.
Gold becomes a safe haven in times when stock markets are extremely volatile. And if a stock market crash is coming, the value of gold will soar.
We like the SPDR Gold Trust (NYSE Arca: GLD). It's an ETF that tracks the value of gold. So when gold prices rise, so does GLD. And it's much easier than purchasing physical gold that requires storage and security and can be burdensome to sell.
GLD currently trades at $117.95, and the stock is up 7.6% this year.
Second, it's important to own shares of companies that will always be in demand.
Money Morning Chief Investment Strategist Keith Fitz-Gerald says stocks in the "Unstoppable Trends" will pay off in the long term. Fitz-Gerald's "Unstoppable Trends" are technology, energy, health, scarcity, demographics, and war. Stocks in these industries are always in demand, whether the market is rising or not.
Raytheon Co. (NYSE: RTN) is a great example of a stock in the "Unstoppable Trends."
RTN is one of the largest U.S. defense firms. It has billions of dollars in contracts with the U.S. government, from cybersecurity to weapons systems. And the United States needs these services whether the stock market is going up or down. That's what makes RTN a great "Unstoppable Trend" play.
RTN currently trades at $151.89 and is up 7% year to date (YTD).
Microsoft Corp. (Nasdaq: MSFT) is another "Unstoppable Trend" play.
Technology is an Unstoppable Trend largely because it is a daily necessity for a huge percentage of the world's population. If equity markets tank, billions of computer users will still log in the day after. And MSFT is one of the leading companies in this industry.
MSFT trades at $64.47 a share and is up 4% this year.
While playing the "Unstoppable Trends" will protect your money in the long term, some investors might be looking for a short-term play during a stock market crash...
Third, investors looking for a quick profit during a market crash should short the broad market index.
Money Morning Capital Wave Strategist Shah Gilani recommends ProShares Short S&P 500 ETF (NYSE Arca: SH).
SH moves inversely to the S&P 500, so when stock prices fall, SH goes up.
This is, of course, not a plan to be followed long term. If a stock market crash is coming, investors will benefit. But if it rises again, SH will fall. To protect on the downside, it has to be bought immediately before a stock market crash happens.
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