Why U.S. Stocks Could Be Headed for a Correction (and What it Means for Canadians)

The U.S. S&P 500 Index is slightly off all-time highs, and there is good reason to think a correction (at the very least) will be coming soon. Here’s what it means for Canadians and how they can benefit by owning names such as Barrick Gold Corp. (TSX:ABX)(NYSE:ABX).

| More on:
The Motley Fool

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

With all three major U.S. indices recently reaching all-time highs, the number one question on investors’ minds is simple: How much higher can the rally progress? In response, there have been no shortage of prominent investors and analysts (ranging from George Soros and Stan Druckenmiller to Prem Wetsa) warning that a material correction is overdue.

These investors should not be ignored. Goldman Sachs equity analyst David Kostin indicated in a recent note that the forward price-to-earnings ratio of the S&P 500 has grown from 10 to 18 since 2011 (a 75% increase). Such a significant increase in P/E has only been observed two times in history (the period preceding Black Monday and the period preceding the tech bubble popping), and the end results were historic crashes.

Of course, it not impossible that today’s markets are significantly different due to historically low interest rates, but with nearly every valuation measure indicating overvaluation—and the gap between the fundamentals and asset prices continuing to diverge—investors should be cautious.

This applies equally to Canadian investors, given the strong correlation between the S&P 500 and the TSX.

The S&P is overdue for a correction

Historically, the length of the current bull market is nearly unrivaled. The current bull market is 89.5 months old as of writing, which would make it the second-longest bull market in U.S. history (only falling behind the tech bubble of the 1990s, which lasted 118 months). The average U.S. bull market lasts 51 months, which puts this bull market 75% above average.

Of course, a prolonged bull market by historical standards would be justified if the underlying fundamentals supported it, but according to a whole slew of valuation metrics, they simply do not. The S&P currently trades at about 18 times next year’s earnings, which is higher than it has been for 88% of its history. Similarly, the Shiller P/E ratio, which divides the total market capitalization by the average previous 10 years of inflation adjusted earnings, is 27. This is compared to the mean of 16.6, and once again can only be rivaled by the bubble conditions of the late 90s.

Markets are supposed to reflect future earnings-growth potential, and if current multiples are justified, then some of the best days for U.S. earnings must be ahead. This does not seem to be the case, however. Earnings expectations for 2016 have been steadily declining throughout the year as the index has been rising, and adjusted EPS growth expectations have been flat for the past three years.

In fact, billionaire Stan Druckenmiller revealed that among U.S. non-financial firms, operating cash flow growth actually peaked five years ago; the growth rate has been steadily declining and has actually turned negative recently. This has occurred as the growth rate for net debt has been accelerating, and the gap between debt and cash flow growth is the largest it has ever been in U.S. history, according to Druckenmiller.

With debt levels rising (very close to record highs) and earnings and cash flow growth declining, it does not make sense that the market is trading at an extremely expensive P/E ratio.

What this means for Canadians

Does this mean a crash is coming for U.S. stocks? It is impossible to say, and the current state of overvaluation has been driven by falling interest rates. What is clear is that the risk level is high, and should there be a large pullback in U.S. stocks, the Canadian market would likely feel it since the S&P 500 and the TSX have shown a very tight correlation historically. Periods where U.S. stocks fall and Canadian stocks rise are rare.

What should Canadians do? Stan Druckenmiller is responding to the risk (as is George Soros) by increasing his exposure to gold. With the current level of risk being high, gold is a smart play, and Barrick Gold Corp. (TSX:ABX)(NYSE:ABX) is a fairly low-risk way to gain this exposure.

Barrick is focused on debt reduction and quality production versus quantity. This should give Barrick good exposure to any rise in gold prices that could come from a stock pullback.

Should you invest $1,000 in Crescent Point Energy right now?

Before you buy stock in Crescent Point Energy, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Crescent Point Energy wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $21,345.77!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 24 percentage points since 2013*.

See the Top Stocks * Returns as of 4/21/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Adam Mancini has no position in any stocks mentioned.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Investing

Man data analyze
Stock Market

How I’d Allocate $5,000 in U.S. Stocks in Today’s Market

Investing in U.S. stocks and ETFs provide Canadian equity investors with geographic diversification in 2025.

Read more »

grow money, wealth build
Stocks for Beginners

Where I’d Invest $5,000 Right Away for Big Future Growth Potential

Are you wondering how to invest in uncertain times? Here are some tips for investing $5,000 for big growth in…

Read more »

man shops in a drugstore
Investing

2 Canadian Consumer Staple Stocks to Buy in Hold in Your TFSA Through Thick and Thin

Alimentation Couche-Tard (TSX:ATD) and another top defensive stock could fare well in a tariff recession year.

Read more »

ways to boost income
Dividend Stocks

How I’d Invest $5,000 in Canadian Energy Stocks to Reach Toward Millionaire Status

These energy stocks can provide investors in Canada with some of the top growth opportunities and dividends to boot!

Read more »

tsx today
Stock Market

TSX Today: What to Watch for in Stocks on Tuesday, April 29

With election results in and earnings season heating up, several factors could sway TSX stocks in today’s session.

Read more »

senior relaxes in hammock with e-book
Dividend Stocks

How I’d Invest $8,200 in Canadian Monthly Dividend Stocks to Pay for My Retirement Lifestyle

If you have some cash on hand, then these monthly dividend stocks can provide you with cash for life.

Read more »

protect, safe, trust
Investing

Protecting a $5,000 Investment: Why I’m Considering These 3 Defensive Stocks

These three top Canadian value stocks look well-positioned to provide portfolio stability and long-term upside for those navigating market turmoil.

Read more »

Canada national flag waving in wind on clear day
Investing

Where I’d Find Value in Canadian Stocks for My Long-Term Holdings

For investors seeking meaningful value (and long-term upside) from top Canadian stocks, here are two great examples to dive into…

Read more »