And if so, how can you escape from it?

The positive dynamics of the American stock market against the backdrop of stagnation in the markets of developing countries can be considered the main investment result of 2013. Analysts perceive a 25% rise in the S&P index as the beginning of a multi-year rally and are encouraging investors to invest in US securities. Since mid-2012, the volume of investments in bonds began to fall, while investments in stocks continued to grow evenly.

But the real situation is not so clear. Quantitative easing, which provided new funds to the market, is ending, and rising consumption costs will take some money away from the market even before the rebound in consumption affects corporate profits.

In recent years, corporate profits have risen to historical highs only due to cost reductions.

With consumption rising, corporations will resume investment, increase spending, and raise wages, which will return margins to normal levels with only a slight increase in revenue. As a result, at least initially, we should expect a decline in profits and dividend payments. At the same time, a large amount of corporate funds already invested in financial markets will return to real business.

These processes should lead to a decrease in the value of individual shares and a fall in the entire market. However, this will only be the beginning. Today, a record amount of margin debt has formed in the American stock market - positions purchased on credit exceed 2% of GDP. A decline in the market will lead to the closing of positions, which will accelerate the fall.

You can look at the situation from a statistical point of view. Today, the American market is trading at a Shiller P/E level (the ratio of the current value of the S&P to the average earnings of its companies over the past 10 years) of more than 24 versus the long-term average of 16. Corporate profits have reached $1.8 trillion. This is accompanied by an unprecedented (twice the average) increase in operating margin (due to cost reductions) - up to 12% of GDP with a long-term average of 6.5%; This ratio crossed the 8% mark only in 2007, 1978 and at the end of the 1940s.

Historically, high Shiller P/E levels have always led to low market returns in future periods. With a P/E of more than 20, the S&P never returned more than 5-6% per annum over the next 10 years, but often gave a negative result.

At the same time, the return from peak values in markets to average occurs quite quickly - within 3-5 years. If, as in all previous economic cycles, operating margins return to 6.5% of GDP in 5 years and the market's P/E valuation returns to 16, even assuming 3% GDP growth per year, the S&P 500 is expected to fall by 58 %! But even after this, there will be room for further reduction - in all previous cycles, the margin to GDP ratio dropped to 5%, and P/E to 10. This means the market will fall by another 50%. Don't think that in a low interest rate environment, high P/E levels will persist. In the 1950s, with rates similar to today, P/E was around 10, and P/E of around 15 was seen in the 1990s and 2000s, with refinancing rates as high as 6%.

Finally, the movement of market prices itself makes one wonder: it is increasingly described by a growing harmonic curve with a rapidly shortening period. According to the repeatedly tested theory of Didier Sornette, a professor at the University of Zurich and one of the best specialists in the world in predicting complex processes, this is important evidence in favor of an early and severe trend change - if you believe the “Sornette curve”, the hour “H” will come at the end of December - early January.

And yet, should the collapse happen “tomorrow”?

Most likely no. Consumption growth in the US is not yet underway; crisis in other countries forces investors to flee risk to American assets; In addition, the ratio of S&P to corporate profits (and to an even greater extent S&P to dividends) is at a high, but not critical level - it has room to grow.

So what should those who already hold positions in the American (and global) stock market do? The reasonable answer may seem counterintuitive: keep holding on.

The current situation in the markets will most likely lead not to a one-time crash, but to long-term stagnation with average annual returns on stock markets of no more than 2–3% for a decade. This is supported by economic growth in the United States, low inflation, and the absence of excitement, usually characteristic of states “before a collapse.” In this situation (with real estate looking even more overvalued and bond markets set to lose value as inflation rises), stock portfolios look like the best of the worst.

It is stocks that allow you to hedge against rising inflation. As inflation rises, even if the real value of shares stagnates, their nominal value will increase, which cannot be said about other asset classes (with the exception of real estate, but its value is highly dependent on demand).

On the other hand, we cannot predict with certainty either a future market crash or the level at which that crash will begin. It is possible that markets will rise another 20%, or even 50%, before collapsing, and after the fall, indices may be higher than today. In 1997, Shiller's P/E was the same as it is today, but the market grew by another 75%(!) by 2000 and did not fall to 1997 levels for 11 years. Even those who didn't sell the S&P in 2005-2006 are in the black today. If they had closed their positions then and bought AAA-rated mortgage bonds, what would their outcome be today?

Moreover, let's assume that the collapse has begun. When is the moment to re-enter the market? Market timing is a thankless task. A 95% drop is the sum of a 90% and a 50% drop.

Who's to say that after entering "at the bottom" you won't lose another half of your investment and hit the cash right before a quick recovery begins?

Isn't it better to stay in positions and, in case of a fall, just wait for the portfolios to return in value?

There is another argument - dividends. Regardless of market value, companies pay dividends. Being out of the market for 5–7 years means giving away 2–3% per year of the current portfolio value: over 7 years that’s 23%. Exiting the market today and entering at the same levels in 7 years (a common practice for those who believe in market timing) will cost the same 23%.

Finally, going out today means paying taxes on your income. Staying in the market means deferring your payout for many years. Although this tax is not so high in Russia, add it to the 23% of lost dividends, and you get a loss close in size to the expected “catastrophic” decline in the S&P. And if we remember that the probability of a fall in the S&P is high, but still not 100%, does it make sense to exit the market?

Before the crash: will the markets collapse?