Opinion: If you’re a 401(k) investor, check your ‘risk aversion’—now

I remember when I was young and signed up for a brief (and unprofitable) spell as a client of a major Wall Street bank, and I filled out one of those silly forms. How “aggressive” do I want to be? “Conservative”? These are meaningless terms. “How much do you want to lose?” is a better question. “What do you do if you open your next 401(k) statement and you lose half of your money?”

I’m still waiting for someone to show me an accurate way to measure how much money I want to lose. Like Harvard’s Daniel Gilbert pointed outWe humans are really bad at predicting how we’ll feel in some hypothetical future state.

This brings us to the present moment.

Like everyone else, I really don’t know what’s going to happen next, and unlike many of them, I’m not going to pretend otherwise. But it’s the perfect time to remember that there’s a perfectly plausible scenario where the stock will actually halve from here on.

That’s right – as they did in 2000 to 2003 and 2007 to 2009, and they will probably do again at some point in the future.

In the face of the same old story, stock market valuations by most long-term measures are higher than at any point in history. Not only higher than 1929 or the late 1960s, but much higher. One reads money manager John Hussman’s perpetually bleak market commentary about one’s risk, but they are a useful antidote to over-euphoria. One of the latest valuation chart, scary presented on what is called a “log” or logarithmic scale, a mathematical tool for reducing extremes visually, and it still looks crazy. “Unless you’re neutral or short, you don’t want to see what this chart looks like Not on a log scale,” he wrote.

The point is not that the market is certain to crash or even likely to crash, but it can happen, and it’s better to find out in advance how that will make you react. is waiting. At this point, I’ve covered so many interesting things on the market that they seem as predictable as Hollywood movies: When you’re my age, you’ll know the plot, including the “sudden twist” ” within the first 10 minutes. This euphoria will end badly. They always do.

And Wall Street will probably be the last to tell you.

Indeed, for the past few weeks, they have been trying to pretend that the economy is currently running so hot that the big risk is inflation.

Meanwhile, all the real economic indicators worth watching are moving in the other direction.

For example, take a look at the chart above. It measures Russell 2000
RUT,
+ 0.46%

Small cap index vs S&P 500
SPX,
+ 1.01%

large-cap index. Quite simply, stocks of small companies tend to be riskier, boom and bust more, and are more closely tied to the domestic economy. So when they’re doing badly against the (supposedly) safer big company stocks, it’s usually a sign that things may be slowing down.

Or look at lumber prices, tied to the domestic economy and new real estate euphoria. The price of lumber has fallen by two-thirds since the beginning of May. Yes really.

During the same period, both the Atlanta and New York Federal Reserves have roughly halved their “current” estimates of economic growth. The economy in the second quarter is still forecast to have to grow strongly, but much lower than expected two months ago.

And this went well before the latest sudden alarm. SG Securities strategist Andrew Lapthorne warned in a research note a week ago: “If recent market movements are volatile, investor confidence in the recovery will evaporate. He added: “(A)many ‘recreate’ plays have all headed south in recent weeks.”

The latest move could be a storm in a cup of tea, an occasional “summer bout” in the stock market, or it could be something worse. We will find it soon. But for anyone taking on too much risk in their 401(k) and IRA, this can be a timely reminder that things go down as well as go up.