There are four things that you always see right before a market crash, whether it's a widespread complete financial crisis or a crash isolated to a specific sector. Knowing how to spot these indicators can give you a heads up before the crash starts and allow you to prepare, protect your portfolio, and potentially even profit from the crash. And the first thing that you always see is euphoria or the fear of missing out. As the saying goes, bull markets climb a wall of worry. In other words, bull markets never die simply of old age.
Bull markets die of euphoria. Everybody expects unreasonable returns forever, thinking they're going to get wildly rich. One recent example would be NFTs. Everybody remembers JPEGs of monkeys trading for thousands and then tens of thousands, then hundreds of thousands, and then even millions of dollars.
This euphoria encouraged people to continue plowing tons and tons of their hard-earned cash into these images. And the fear of missing out caused even more people to rush in. And eventually, some people were left as the bag holders as the prices collapsed and they lost everything. Another example, a little bit older, is the Great Financial Crisis. Before that, there was a ton of euphoria.
real estate. Now, the aftermath of the financial crisis is what most people remember. Those memories are going to overshadow everything that took place before, especially because they involve loss and devastation and fear.
But what most people don't remember is the euphoria and the fear of missing out that happened right before the crash started. Either you or somebody you know thought that they were going to retire extremely early and get wildly wealthy because they were buying real estate that was virtually guaranteed to go up. and go up fast.
It's caused many households to become extremely over leveraged, not pay attention to the terms of the loans that would get more expensive very soon and pay no attention to the fact that there is no way for these things to provide the income that they needed in order to cover the cost. It's euphoria paired with people fearing missing out on getting rich, cause too much money to rush into real estate, causing the big bubble. and then the crash.
One way to identify the euphoria, at least in regards to the stock market, is by looking at the fear and greed index. You can find this simply by Googling CNN fear and greed index. As of the time of this recording, the market is solidly in the fear camp, nowhere near the extreme greed that you see whenever there is euphoria or the fear of missing out in markets.
Another place is just to watch social media and see what people are talking about. You can look on forums like Wall Street. bets on Reddit. You can watch TikTok. You can look on Twitter.
And if you're looking for it, you will find the areas where people have euphoria or fear of missing out in certain sectors, or you'll notice if it's broad sentiment regarding the market overall. One other little trick to watch out for that will tip you off as to whether there's euphoria or fear of missing out is when you have aunts or uncles or extended family members that have never purchased a stock in their life suddenly asking you, hey, how do you get invested in this thing? I don't understand what cryptocurrency is, but I heard there's this new coin that's going to make everybody rich.
How could I get in on that? Signs like that are sure signs that there's euphoria and FOMO building and a crash is right around the corner. Now, the second thing that you see right before a crash is illogical valuations. In other words, there is no sustainable path to profitability for that asset class. Now, it may be that a certain asset class is...
profitable, but only barely. So whenever you're talking about profitability, we have to say compared to what, because if you have a money printer that prints you out $1 every single year, you are certainly not going to pay a million dollars to acquire that money printer because the return on your investment is extremely small. Yet many times right before a crash, this is the exact profitability ratio that you see in many assets.
They might be producing a little bit of profit. but compared to the price you have to pay to get your hands on that profit, there is no potential way that that asset class will ever grow its profit to the point that will make your investment worth it. One example of this is the dot-com bubble where companies were receiving insane valuations simply because they attached the words dot-com to their name in order to capitalize on the internet craze.
We've all heard of companies like pets.com that ended up going down. bankrupt simply because there was no real business there to begin with. You can even look at companies like Amazon, which obviously today is one of the most valuable companies in the world, but it was not immune from this effect. It was an internet company and had a massive bubble with a massive crash.
Now you can plot this average growth that happened before the dot-com bubble and the average growth that it had after the dot-com bubble. And you can see. that if you just ignore this big bubble and the big crash, it continued fairly steady on that average trend line. But even a powerhouse like Amazon was not immune to the illogical valuations that .com and internet companies were being assigned.
And at these prices, even Amazon was illogically valued. In other words, it was way too expensive for the money that it made at the time. A current day example of this very well could be.
the AI bubble. We are seeing very similar comparisons being drawn between how AI will transform the entire world and the economy versus how people used to talk about the internet. And while that may be true over the long term, you have to pay attention for the fact that you might have illogical valuations to the point where there is no possible way for the company to earn the type of money that would need in order to make your investment at that price.
And that's an indication that the valuation will soon come back down to earth to a point where it does make sense. An example of an AI stock that could be exhibiting characteristics like this might be Palantir. Palantir has a price to earnings ratio of 599 and earnings per share of only 21 cents.
And yet it has a market cap. In other words, a valuation of $267 billion. To put that in perspective, we can compare it to AMD, which is not an AI stock, but it is a tech stock.
And we can see they have a price to earnings ratio of only 110, earnings per share of a dollar, and yet they have a smaller market cap at only 180 billion. In other words, Palantir in 2024 had a net income of $462 million, whereas AMD had a net income of 1.6 billion. And yet the market is saying Palantir is worth $267 billion, but AMD is only worth $180 billion. I have no trade recommendation here. This is simply an example to point out that sometimes the market can assign valuations to companies based on expectations about future growth that may not be possible.
And when you see this type of valuation spread across many names in one asset class, that is a sure sign that a crash is around the corner. The third thing you see every time before a crash is a little bit more macro based, but this one is changes with monetary or fiscal policy. Monetary policy has to do with what the Federal Reserve does.
That's usually quantitative easing or quantitative tightening or raising or lowering interest rates. Fiscal policy refers to what the treasury does. In other words, what the...
government does either with taxing or with spending. Either one of these by themselves or sometimes together, they can make moves that will restrict liquidity. In other words, suck cash out of the financial system. Whenever you see changes by the Fed or the government that restrict liquidity, usually a correction or a crash is right around the corner. A recent example of this is when the Federal Reserve finally decided to stop its money printing at the end of 2021. which marked almost to the week the top in the S&P 500 before it declined 27% from top to bottom.
And if you were invested in the NASDAQ, you fared even worse with the drawdown from top to bottom being 37%, all because the Federal Reserve changed its monetary policy from one where it was injecting money into the financial system into one where it was pulling money out of the financial system. They did this in order to combat inflation, but- one of the main consequences was a drawdown and a crash in asset prices. So far, we are not seeing anything of the sort happen. And one way to measure this is simply to look at the money supply.
If you don't wanna have to take a look at tax policy, whether they're raising or lowering taxes, whether they're raising or lowering spending, whether the Federal Reserve is manipulating interest rates up or down, whether they're increasing or decreasing their balance sheet, the easiest rule of thumb here is to watch the money supply. M2 is the most widely accepted measure of the money supply in the United States. And you can see that for at least a year, it has been heading higher.
And at least right now, there's no sign this will be doing anything other than that. Backing this out to five years, we can see that at the end of 2021 was really when the Federal Reserve stopped doing things that were increasing the money supply. The money supply was volatile, but largely moved sideways for the next couple of months before starting to head down into 2023. And again, the end of 2021 is exactly when markets topped. Now, the money supply is a lagging indicator, which means you will not see it respond usually until markets have already started to make a move. And so if you want some advanced notice, then you will need to pay attention to what the Federal Reserve is saying, whether they're signaling, hey, we're gonna start raising rates in the future or what the federal government is saying about fiscal policy, tax policy, spending policy and paying attention to those together will give you an idea of where liquidity is headed in the future.
Now, the fourth and final thing that you always see right before a market crash is people who have no business getting rich are number one, getting rich. Number two, they're telling everybody about it. And number three, they're telling everybody how to do it as well.
In other words, idiots are getting way richer than they deserve. Now, I don't say that to be mean, but you all know people who in past cycles of booms and busts of euphoria and crashes have gotten sucked into the scams. And initially they think they're getting rich and they think they're smarter than everybody. So they're telling everybody else about it, bragging about it, boasting about it.
And then when the crash comes, suddenly they get silent. Another test for this criteria is called the Uber driver or the dentist test. If you have an Uber driver or your dentist.
start giving you stock tips and telling you that they're going to be able to retire soon because of how rich they're getting with a specific investment. That's an example of somebody who has no business making money in a certain area, getting wildly rich. And because of their lack of sophistication and experience and knowledge about that area, most of the time what happens is by the time they start to get rich, they're going to be left holding the bags. So given these four criteria, where do we stand today? with the market overall.
Well, we already looked at the fear and greed index is still in the neighborhood of fear. And while the stock market overall is near all time highs, it has experienced some extreme volatility recently and has held up through some pretty negative news about the market. There is certainly some euphoria isolated in certain sectors of the market, but it is definitely not widespread. So we cannot check the euphoria box, at least widespread across the market right now. The second criteria is valuations.
Here again, there are certain sectors and areas where valuations seem extreme. I would put things like AI into that bucket. But a rotation from overvalued areas in the market into undervalued areas in the market is fairly easy to plan for. And as long as you have at least a few specific funds that give you broad exposure, then you are able to rebalance between those funds and take advantage of that rollover or the transfer of wealth from one sector to another without it negatively impacting your portfolio overall.
And because we don't have the extreme illogical valuations across the market as a whole, it means that a correction in one area is likely to occur at the same time as we see a bull market start in another. The third criteria that we have of looking at liquidity restrictions from monetary or fiscal policy looks like we have nothing to expect into the future except for more money printing. We are going through an inflationary deleveraging right now where the federal government must deal with the cost of its overbloated debt load.
It has to do that by devaluing its currency. In other words, causes inflation to happen so it can offload the pain of that debt onto the economy. We will see this.
even if we see large spending cuts from the current administration, because they will be paired with tax cuts, which means the deficit will remain largely the same. This borrowing will occur as a result of lending money into existence through the banking system, which drives up the money supply, keeping prices elevated and interest rates stay high for all of us as well. This is what inflationary deleveragings look like. They take place over long periods of time, decades, and it has happened before.
And it looks to be happening again right now. This means that a widespread extreme financial crisis or crash in the overall stock market, at least for now, seems to be unlikely. And then finally, for the very last one, where you have idiots getting richer than they should, this is not a widespread phenomenon like it was back in 2020 and 2021, when you had people quitting their jobs when they were 21 years old, day trading, wearing Rolexes and posting their gains on TikTok.
That's not happening today. And in the few areas that you might see that happening, It is usually exposed to just a single area of the market in which you might expect a correction or it's just outright fraud. And these people aren't actually making the money they're saying they're making. There's always volatility during regime changes, and that's what we are seeing right now. Our economy is not very free, which means there is a lot of central planning.
In other words, decision making at the top on the allocation of resources across the economy. And as a new ideology takes power. the direction of those resources will change, which means some areas that were doing well before will no longer be doing well, and other areas that were not doing well before will start to do well. But the four markers that you would see right before a widespread collapse are not yet present, at least for now.
Remember, bull markets climb a wall of worry, and they die of euphoria, not of old age. There are three things that you can do to protect your portfolio and potentially even profit from a crash, even if you're focusing on just specific areas. Here it is. that might exhibit all four of these characteristics. The first thing that's very easy to do is implement trailing stops on your positions.
A trailing stop is a sell order that will trigger if your position drops by a specific amount. But if your position continues to climb higher, then your stop order will continue to climb higher with your position as well, which means at any given time, the most you could potentially lose before your stop order getting triggered will be the amount that you set it by. In other words... You can keep on making money on the way up, but if it ever starts to drop, then you will exit at your predetermined exit point.
One downside with this is you could end up getting whipsawed or stopped out. That means you get sold out of your position right at the bottom, and then the position continues to head higher from there. If you want to avoid something like this from happening, you can purchase out-of-the-money puts. These are option contracts that are relatively cheap compared to the...
underlying position, but they will increase in value for you. If your stock starts to drop, this is not going to be a one for one hedge. Many times you will make very little money. If the stock drops a little bit, or you will make a lot of money.
If the stock drops a lot, the third thing you can do is if you already have a decent profit in the position, you can take some profits off the table, sell some of your position and keep that cash on the sidelines. If the stock does correct from there, you now have dry powder to purchase back in at a fair value or at a discount, allowing you to accumulate more shares than you would otherwise have over the long-term. Assuming it's a solid long-term growth position, you will accumulate more and more shares over the long-term rather than just sticking with your original position through all the ups and downs.
I'm constantly sending out asymmetric trade ideas that give you the potential to make more money than you can lose to my private group. So if you are interested... in learning more about how to implement ideas like this into your own portfolio and having me help you with that, go ahead and click on the link in the description below. As always, thank you so much for watching. Have a great day.