Preparing for the Next Market Crash

Twice a year — in April, after US taxes are complete, and six months later in November — I do a full accounting of our household’s financial assets, then run some projections for retirement dates and major financial outlays.

It’s all happening a little late this year, because by the time you count preparations and recovery/catch-up time, our eleven-day road-trip-with-dog in early April ate up more than a month of my life. (This is much of why Nine Lives went on hiatus in February. Other reasons include a major vegetable garden project, increased animal care, a death in the extended family, and prep work for stage two of our house repair/remodel, coming later this year.)

A few of you have known me long enough to remember back in the aughts when economics — micro, macro, and behavioral — was my primary area of study (aka Autistic fascination) and I kept a personal finance blog, Pocketmint. One thing I learned very early is that the best strategy for an ordinary investor — someone who’s saving long-term for something big like a house purchase or retirement — is to put the ‘stocks’ portion^[1] of your investment portfolio in a total-market passive ETF and leave it there.

Not a mutual fund, because actively-managed funds both perform worse on average than passively-managed ETFs, and also charge more in fees — typically twenty to thirty times as much. Definitely not narrow sector funds or specific stocks — as an amateur, small-time investor you will consistently be on the losing side of information asymmetry; you might get randomly lucky, but it’s kind of like taking your future house, or your ability to ever retire, out for a wild night at a Vegas casino. The odds are never in your favor.

Betting on the total stock market is still betting, but it’s a much safer bet because it’s highly diversified — your eggs are spread out across thousands of different baskets. And while any given year might be a roller coaster ride, over a period of decades you can safely assume you’ll come out ahead.

I’ve been holding stocks almost exclusively via Vanguard’s VTI (Total Stock Market) ETF since I first started seriously saving for retirement around two decades ago. I hold Vanguard ETFs because Vanguard is shareholder-owned with no outside investors, meaning its fees are reliably minimal and — most critically — it’s not subject to conflicts of interest.^[2]

None of that has changed. But this April I noticed something that set all my alarm bells ringing, something that caused me to start selling off VTI in our IRAs for the first time ever.

This is a problem with the entire US market, and every mutual fund or ETF based on it.

This is not a problem with VTI in particular, it’s a problem with the entire US market, and every mutual fund or ETF based on it. The stock market is wildly lopsided right now: the technology sector alone accounts for around one-third of US market capitalization — half as much as the other ten sectors combined. That’s a very recent change — at the end of 2018, tech accounted for less than one-eighth of the total market.

This is particularly alarming because I know that technology stocks are in a giant bubble. The pandemic did tech companies a lot of favors, but since 2022 their outsized growth has been largely based on the hype and grift around generative AI — all the false claims about the current and future capabilities of LLMs, and the lie that AGI (artificial general intelligence) is just around the corner.

(I’m not going to spend any time here trying to convince enthusiastic proponents of “AI” that tech stocks are in a giant hype bubble. Many other people have covered that thoroughly.)

At some point, that bubble will burst — the only question is when. It could be next week, or it could be in two years; if I had to guess, I’d say closer to the former than the latter. (It’s even possible that it’s already started — the true beginning of the end is never obvious except in hindsight.) But I fear this won’t be like the cryptocurrency bubble, or the NFT bubble, which primarily affected those people who bought cryptocurrency or NFTs.

No, with tech making up a third of the US stock market — with the companies most heavily invested in AI including some of the largest companies in the US (and the world) — I fear that that when those tech stocks do correct for the AI-related overvaluation, we’re in for a huge overall market crash. Think ‘2000 Dot-Com Bust’ or ‘2007 Financial Crisis’ territory.

International markets aren’t nearly as overinvested in technology as the US market is, so I can hope that the coming reckoning won’t spark another global crisis. I did already have a fraction (around 10%) of our retirement savings in international stock market ETFs, but I hadn’t been too worried about exactly how much — expense ratios are higher for international stocks, most major US companies are highly globalized, and the US is almost half the world market anyway. Now I’m worried that it’s not nearly enough.^[3]  So I’ve been starting to sell off some of my VTI in exchange for more VXUS — and domestically, for VTV.

All stocks are considered high-risk compared to bonds, but within the stocks category some are quite a bit riskier and more volatile than others. Those are the “growth” stocks, and they include all the big technology companies like MSFT and NVDA and META whose current prices reflect the AI bubble. At the other end of the scale are “value” stocks, which is what what the second V in VTV stands for.

VTV is still a fairly broad stock ETF, but it’s tilted toward stocks that are trading below their intrinsic worth, as opposed to betting on future growth potential. (Value investing is what made Warren Buffett rich and famous, and not coincidentally, VTV’s single largest holding is Buffett’s Berkshire Hathaway.)

VTV’s top ten holdings include only one tech stock (Broadcom, a semiconductor manufacturer), whereas eight of VTI’s top ten are tech stocks. (Again, this is not specific to Vanguard, but is also true for ITOT, SPTM, and other total market index ETFs; all of them merely reflect market conditions.) VTV’s total tech exposure as of April 30 was 9.5%, compared to 32.1% for VTI. So a portfolio of, say, half VTI and half VTV would hold technology stocks at a more reasonable level of around 21%, and be more buffered against a tech-sector crash.

Trying to time the market is tempting, but it’s a fool’s game for anyone who isn’t a full-time professional investor. I’m lowering the risk of bad timing luck by making the transition out of VTI in stages, in a kind of dollar-cost averaging, as opposed to just selling and buying everything all in one go.

By even beginning to lower my exposure to tech stocks now, I may lose out on some of the upside if the AI bubble continues to expand for months or a year before it pops. I’m okay with that, because the downside of getting caught with ~70% of our savings in a crashing stock market this close to retirement is significantly worse.

People who don’t need to worry about this include:

• anyone with wealth of eight or more figures (who have way more money than anyone could ever need, so losing a big chunk of it won’t measurably affect their lives), and
• young people who don’t need access to their funds for twenty-five or thirty more years (that’s enough time for a portfolio to recover from any major shock).

Neither of those things describe us; our paltry six-figure portfolio represents two decades of careful savings and sacrifice, and in less than a handful of years we will need to begin tapping it for basic living expenses.

If you are American and have savings invested in the stock market — well, first of all, congratulations! Only 60% of people have made it that far. But if you actually expect to need any of that money in the next twenty years — not just for retirement, but for a house purchase, or college, or anything else — you might want to check how much of it is tied up in the tech sector, and consider making some judicious changes before the weasels go pop.

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