The Slow-Motion Stock Market Crash
When my book "Rich Dad's Prophecy" was released in 2002, most financial newspapers and magazines trashed it because I discussed a looming stock market crash. Ironically, much of what I predicted in the book is coming true earlier than I expected.
On Feb. 27 of this year, a 9 percent market sell-off in China sent ripples of fear through stocks markets across the world. In the United States, the Dow's one-day plunge of 416 points was the steepest decline since the market opened after Sept. 11, 2001.
So the question is: Should stock investors be worried? As you might expect, some say yes and some say no.
Correction or Crash?
Personally, if I were counting on the stock market for my retirement or to put my kids through college, I'd be worried. Why? Because from my perspective, even if the Dow were to miraculously soar through 15,000, the stock market has been experiencing a long, slow crash for years.
This February, investors witnessed a drop of $583 billion in U.S. market wealth. Many experts are quick to point out that this loss of wealth is a mere drop in the bucket when you take into account that the stock market has been going up for four years. Most market experts say that the market was due for a correction, which is true.
In fact, the recent 3.5 percent drop is miniscule when compared to the 21 percent drop of the S&P 500 back in 1987. By definition, such a small drop isn't even classified as a true correction. According to BusinessWeek, a full-fledged correction is defined as a 10 percent drop, and a bear market is defined as a 20 percent drop.
Comparing Apples to Oranges
So how can I say that the market is crashing even if it continues to go up? To see the true crash, educated investors need to compare apples to oranges, not apples to apples.
When you compare the Dow to the Dow, or the S&P 500 to the S&P 500, that's comparing apples to apples. The Dow at 12,000 appears better than the Dow at 9,000, just as an apple at $1 a pound looks better than at $1.50 a pound, even though it's still the same apple. All that's happened is the price per pound of the apple has gone up -- the apple hasn't changed.
Years ago, my rich dad taught me to be a comparison shopper, especially when it comes to investments. He said, "You need to understand value more than price. Just because the price of something goes up doesn't necessarily mean the value has gone up."
He also told me, "If prices go up without a corresponding increase in value, it means the value of the asset has actually gone down." This holds true for all assets, including stocks, bonds, and real estate.
For example, when the price of a house goes up it doesn't mean that the house is more valuable. And prices going up may mean that something else is going down in value. In today's global markets, what's going down is the purchasing power of the U.S. dollar.
The Dow vs. Gold
To get a truer picture of comparative values, compare the Dow to the price of gold. When the purchasing power of gold is compared to the purchasing power of the Dow, the Dow appears to be crashing.
That means the average investor will need at least a 15 percent annual return on their stocks or mutual funds just to stay ahead of the U.S. dollar's purchasing power erosion -- that is, just to break even.
In my earlier Yahoo! Finance columns, I used history to forecast the future by comparing the dollar to gold and oil over a 10-year period. Here's the data:
Table updated 3/21/07.
What this means for you depends upon your bullish or bearish outlook, your financial education, and financial experience. For example, I hear many young people today saying that the price of real estate doesn't go down. This is a naive opinion due to lack of financial education and experience. I heard similar misguided opinions about stocks in the dotcom era, just before the market crashed.
Personally, I tend to heed former Federal Reserve Chairman Alan Greenspan's caution about a possible recession ahead. I predict that if there is a recession, current Fed chairman Ben Bernanke (and, in an attempt to hold onto the White House, the Republicans) will flood the market with more money at lower interest rates.
Then the purchasing power of the dollar will once again drop, asset prices may rise, and the financially naive will actually believe that the value of their assets -- houses, stocks, and mutual funds -- have gone up in value.
Thanks to Mike Maloney, my go-to guy for information on gold and silver.