Heat check: What is the current state of the stock market?

Markets are on fire — just not in the way investors would want. In the past few weeks, strategists warned of several threats to the economy which could lead to large market swings.

The most bearish of them all, Morgan Stanley, forecasted a 20% drop in the S&P 500. Just how bad can it get?

What will the next decade look like?

The stock market has been on an absolute tear for the past decade. The S&P 500, the benchmark for the market average, has given investors average returns of:

• 13.91% annually in the past 10 years.
• 15.90% annually in the past 5 years.

This is much higher than the average 9.95% in the past 121 years. But assuming continued high returns is dangerous. Between 2000-2010, the S&P 500 only averaged 0.85% return annually — a lost decade for stock returns.

How will the market perform in the next decade? It’s anyone’s guess. But in the long-term, we can count on one thing: finding cheap, high-quality companies and holding — or index funds.

All the reasons to be pessimistic

There are many reasons to be pessimistic about the market in the short term.

• Evergrande’s debt problem is spreading into a global contagion.
• Stocks are looking expensive on almost every valuation metric.
• Fluctuating COVID cases is preventing the economy from fully recovering.
• The number of analysts raising earnings estimates for companies is slowing.

According to FT, every time the market corrected this year, retail investors bought ETFs in the dip — but the amount of buying dropped by over half since July. Don’t count on investors supporting these dips forever.

Investors: Brace yourselves

Here’s what investors can do to prepare for a potential market correction.

• Get defensive — Move into stocks with stable earnings regardless of economic conditions.
• Cleaning your portfolio — Got a stock you’ve been looking to sell at the right time? Now might be it.

And what happens if we see a correction? Long-term investors, stay the course and ride the market. Got extra cash ready? Buy the dip and load up on your favorite positions.

On the bright side, the historically weakest week (4th week of September) of the market is coming to an end. And if you look very carefully, there are reasons to be optimistic for 2022. Just 3 months left in 2021.