Is greatest stock market crash looming? Be aware and prepare

If history is an indicator, the greatest stock market crash in history may be coming within the next few years, as some observers indicate.

I’m not a stock broker, market analyst or fortune-teller. I’m not a short-seller, options dealer or a doomsday believer. I won’t make any money by what I’m about to tell you. I’m an internal auditor by day, monitoring risks and threats to my company, and I’m a preparedness guru by night, hoping for the best but preparing my family for the worst.

You don’t have to believe a word I write because no one is responsible for your financial future except you. However, if you have money invested in the stock market, a 401(k) or an IRA, you may want to factor into your retirement decisions certain market conditions that some observers indicate draw a bad picture of the stock market.

Inflation adjusted price-to-earnings 10 ratio for the S&P 500 index is overvalued.

Many market analysts consider price-to-earnings ratios an indicator for the value of a stock. The inflation adjusted P/E10 ratio for the S&P 500 is calculated by taking the monthly averages of daily closing prices divided by the 10-year average of earnings. If you’re an investor, this P/E ratio can be directly converted to how many years it would take for a company to earn enough profit per share to buy a single share. Historically, anything below 11 means the stock is undervalued, with the average being around 16 and anything more than 21 meaning it is overvalued.

This ratio reached an all-time high in December 1999 at 44.2. It sunk to 13.3 in March 2009 and rose again to overvalued territory, hovering for the past year around 21. From a historic perspective, over the past 140 years we’ve seen this ratio fluctuate up and down, peaking above 22 on only four occasions. Each time it peaked it subsequently sank to single digits, but it has yet to sink to single digits this time.

“To reach a P/E10 in the high single digits would require an S&P 500 price decline below 540,” said Doug Short, Vice President of Research for Advisor Perspectives who calculates and tracks this P/E10 ratio. “Or was March 2009 the beginning of a secular bull market? Perhaps, but the history of market valuations suggests a cautious perspective.”

Dividend yields are near historic lows.

The dividend yield is a financial ratio that shows how much a company pays out in dividends each year relative to its share price (dividends per share/price per share). The S&P 500 index dividend yield sits at a very low level of 1.97 percent as of Aug. 3. From a historical perspective, this yield in August 1982 hit a temporary peak of 6.24 percent when the S&P 500 index’s price was at 100. The yield declined for 18 years until it hit an all-time low of 1.16 percent in January 2000 while the S&P Index soared to an all-time high of 1498, moving in opposite directions of each other until today. This means stock prices moved up faster than dividends (remember the formula) and either companies need to start paying more dividends to keep up with their stock prices or prices need to come down. Dividend yields are already near historically low levels so will the yield decline further, or will the yield continue its upward movement?

The Employee Retirement Income Security Act of 1974 forces individuals to withdraw IRA and 401(k) funds at age 70.5 because otherwise there is a penalty of up to 50 percent. Baby boomers will start reaching age 70.5 in 2015. That means 2.2 million baby boomers will be forced to sell a portion of their stock or be fined. In 2016, another 2.9 million baby boomers will be forced to start selling, and so on as the years continue. Will this have a negative impact on the price of stocks? I'm not sure, but for every seller of stock there also has to be a buyer. Will demand for stocks be able to keep up with supply or will the oversupply of those selling force prices down?