For investors, things just about couldn't be better. The benchmark S&P 500 (SNPINDEX:^GSPC) has more than doubled since hitting its coronavirus pandemic low on March 23, 2020, and it's, thus far, gone the entirety of 2021 without so much as a 5% correction.
Unfortunately, a number of historical metrics would suggest that this rally isn't sustainable, and that a stock market crash or sizable correction could be on the way.
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History may prove unkind to the stock market in the near term
For example, even though the internet has democratized trading and helped to expand price-to-earnings multiples over time, the current valuation multiple for the S&P 500 is nothing short of worrisome.
As of the end of August, the S&P 500's Shiller P/E ratio -- which takes into account inflation-adjusted earnings over the previous 10 years -- was above 39. That's the highest level in about two decades, and well over double the average Shiller P/E for the broad-based index dating back 151 years. However, the bigger concern is that in the previous four instances where the Shiller P/E surpassed and sustained 30, the S&P 500 subsequently lost at least 20% of its value. In other words, the precedent has been set that the S&P 500 gets hit hard when valuations become this extended beyond historic norms.
There's also the fact that crashes and corrections are quite common. Data from market analytics company Yardeni Research shows that there have been 38 double-digit drops in the S&P 500 since the beginning of 1950. Even though the market doesn't adhere to averages, we're talking about a double-digit decline occurring, on average, every 1.87 years. Considering how quickly the market has bounced back from its March 2020 low, it wouldn't be surprising to see this average double-digit decline timeline coming into focus.
A final front-and-center concern can be seen in the way equities bounce back from bear markets. In each of the eight bear markets prior to the coronavirus crash (dating back to 1960), there was at least one, if not two, double-digit declines in the S&P 500 within three years of reaching the bottom. Put another way, bouncing back from a bear market is a process and not the straight line higher that we've witnessed in recent months.
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A stock market crash would be your opportunity to pounce on these high-quality stocks
But no matter what the stock market does in the near term, buying and holding stakes in great businesses has long been a surefire way to build wealth. Since 1980, the S&P 500 has averaged an 11% annualized total return -- and that includes five bear markets.
If a stock market crash were to occur, it would represent the perfect opportunity to buy these three stocks hand over fist.
Amazon
To be honest, there is no such thing as a bad time to scoop up shares of e-commerce giant Amazon (NASDAQ:AMZN). But if you can manage to snag shares of this highly successful company at a discount during a crash or a correction, you should jump at the opportunity.
Despite retail being a highly competitive space, Amazon has carved out the lion's share of online retail in the United States. According to an April report from eMarketer, Amazon's marketplace will handle roughly $0.40 of every $1 spent online in the U.S. this year. For some context, Walmart is No. 2 in online retail, and it's expected to control $0.07 of every $1 spent online in 2021.
What's been particularly valuable for Amazon is the ability to utilize its online dominance as a means to sign up 200 million people to Prime worldwide. In a general sense, retail margins are quite low. But adding tens of billions of dollars in annual subscription fees via Prime helps buoy these margins and ensures that Amazon continues to undercut its competition on price.
Although Amazon is known best for its online marketplace, it's actually the company's ancillary operations that are key to growing its cash flow. For instance, Amazon Web Services is the world's leading cloud infrastructure provider. Since the margins associated with cloud infrastructure, advertising, and subscription services are notably higher than retail, they're the ticket to Amazon more than doubling its operating cash flow by the middle of the decade.
Image source: Getty Images.
Trupanion
Another smart way to pounce during a stock market crash is to buy into pet stocks, such as companion animal health insurance provider Trupanion (NASDAQ:TRUP).
Though the pet industry isn't growing by leaps and bounds like cloud infrastructure, cybersecurity, or other innovation-driven trends, it's one of the most consistent growth trends in this country. U.S. pet expenditures have grown year over year for at least of a quarter of a century, and the expectation is that U.S. pet owners will shell out nearly $110 billion in 2021 for their four-legged companions. No short-lived market crash is going to disrupt owners' desire to keep their pets happy and healthy.
This past quarter, Trupanion hit a milestone. It surpassed 1 million total enrolled pets, with more than 643,000 pets enrolled in its insurance subscription segment. What's particularly intriguing about this operating model is that Trupanion has only penetrated about 1% of the U.S. companion animal market. If it were to reach the 25% penetration rate of the U.K. market, Trupanion's addressable market would climb to close to $33 billion.
Furthermore, Trupanion has been building rapport with the veterinary community and clinics for two decades. Even with increased competition, these partnerships, along with the payment-level software Trupanion provides vet clinics, makes it the undisputed leader in pet insurance.
Image source: Getty Images.
Vertex Pharmaceuticals
A third stock to buy hand over fist if a crash or correction occurs is specialty biotech company Vertex Pharmaceuticals (NASDAQ:VRTX).
One of the greatest aspects of healthcare stocks is their defensive nature. Because we don't get to choose when we get sick or what ailments we develop, there's a relatively steady demand for drugs, devices, and healthcare services no matter how well or poorly the economy (or stock market) is performing.
What allows Vertex Pharmaceuticals to stand out is the company's success in treating cystic fibrosis, a genetic disease characterized by thick mucus production that can obstruct the pancreas and lungs. Vertex has developed multiple generations of CF treatments, the latest of which targets a mutation affecting about 90% of CF patients. This combination therapy, Trikafta, was approved five months ahead of its scheduled review date by the U.S. Food and Drug Administration and is pacing $5 billion in annual run-rate sales in less than two years on pharmacy shelves. This CF revenue stream is well protected from competition.
Equally important, Vertex is sitting on a treasure chest of $6.71 billion in cash, cash equivalents, and marketable securities. This is more than enough capital to fund the internal development of close to a dozen compounds, and could allow the company to make acquisitions. It's not common for a biotech stock to be both a growth and value stock, but that's exactly what investors are getting with Vertex.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. 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.
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