Saturday, June 12, 2021. I haven’t written of such things in a while, but NOW is certainly a good time to do so.
IF you are a beginner, a novice, new to investing… you’ve come to the stock market at one HECK of a time. I’m sorry. But here’s the simple truth… The stock market, in general, and I am referring to the entire thing, and not every stock in particular, is at an extremely high valuation by just about any measure that has been contrived… and not only are these measures at extreme highs, but they are all at NEW ALL-TIME, NEVER-BEFORE-SEEN HIGHS! That’s NOT a good thing…
Pay close attention to the following:
“Three Valuation Metrics Signaling High Risk Today
The Most Reliable Historic Measures of All-Time-High Valuation
The first and simplest metric signaling higher risk in stocks today is the S&P 500 Index’s price-to-sales (P/S) ratio.
Historically, this ratio has been highly negatively correlated with subsequent 10- and 12-year average annual returns. That means that when the ratio has been high, stocks have tended to perform poorly afterward. When it has been low, stocks have tended to perform well afterward.
Within the past few years, the P/S ratio has peaked twice just months before a large correction.
As you can see in the following chart, it peaked around 2.34 in January 2018 (its highest level since the dot-com high in March 2000). The S&P 500 then fell nearly 20% starting in late September, bottoming on Christmas Eve. In January 2020, the P/S ratio peaked again at 2.30. One month later, the S&P 500 began its pandemic-induced tumble, closing down 34% by March 23.
The P/S ratio hit a new all-time high of 3.14 on April 30, just over one month ago. It’s still very near that level today.
The second important valuation tool for the overall stock market is the ratio of total market cap to gross domestic product (“GDP”). This metric gained in popularity after the father of value investing Ben Graham taught it to his star pupil, Warren Buffett.
At the top of the housing bubble in June 2007, the indicator stood around 1.06. At the top of the dot-com mania in March 1999 – until recently, the single-most-expensive moment in U.S. stock market history – it was at 1.5.
Today, it stands at an all-time high of 1.98.
The Hussman Funds
The third metric is really a group of five market-valuation metrics that economist and portfolio manager John Hussman tracks at Hussman Funds. (P/S is one of the five. I presented it separately in this writeup because it’s the easiest for you to track independently and the easiest to comprehend.)
Hussman found these five metrics have the highest negative correlation with subsequent 10- and 12-year S&P 500 returns. When the metrics have been high, subsequent returns have been low and vice versa. Right now, they’re at the highest levels ever recorded.
Either all these metrics are broken, or right now is one of the single-riskiest moments in stock market history.”
But wait, as they say… There’s MORE!
“Three Measurements of Investor Sentiment
Now let’s turn to investor sentiment. This is hard to quantify, but it boils down to a simple observation of human nature: Investors tend to be most bullish after stock prices have risen and most bearish after they’ve fallen.
Being bearish most of the time is a losing proposition… Equity prices have tended to reflect humanity’s ongoing progress, rising over the long term and providing risk takers with adequate returns. But every decade or so – usually after a period of excellent returns like the market’s 65% run-up since last March – investors get very bullish when they should be more cautious or even outright bearish.
Let’s look at three sentiment indicators flashing “high risk” lately…
First, there’s TD Ameritrade’s Investor Movement Index (“IMX”). This is a proprietary, behavior-based index based on a sample of the firm’s 11 million funded client accounts. The sample changes each month and encompasses all ages, account sizes, and experience levels. The IMX data go back to 2010 and have been higher only once – in late 2017, roughly a year before the near-20% correction of late 2018.
Second, there’s the Goldman Sachs Bear Market Probability (“BMP”) Index. This index is constructed monthly from five inputs and ranked by where it stands against all historical readings. The higher the indicator, the higher the chance of an impending bear market.
As you can see, the BMP Index hit nearly 80 (“0.8” on the following chart) in November 2018. That was the highest bear market risk in 50 years. The market took a dive not long after. Today, the index is at 65. That’s not great, but it’s not disastrous. If it hits 70 soon, that will be cause for much greater concern.
Overall, the probability of a bear market is historically above average and rising.
The third investor sentiment metric isn’t a metric at all. It’s an opinion based on a chart by technical analyst and author Justin Mamis that represents changing investor moods over a full bull and bear market cycle.
The “buy the dip” moment on this chart came in March 2020, when stocks plunged as the pandemic began. Right now, we are at or near the “enthusiasm” moment again – the single-riskiest moment in the cycle…
This is purely an opinion, of course. There’s no objective method for determining where on Mamis’ chart the stock market is at any given moment. Perhaps I’m wrong, and we’re merely at the “anxiety” phase. It’s impossible to be certain. That’s why we don’t base our strategy on the accuracy of our predictions but rather on our ability to prepare for a wide range of outcomes.
So What Should You Do About This Heightened Risk?
The heightened risk we see in the overall market does not mean you should sell stocks. Selling stocks right now would amount to a prediction, and we don’t do predictions.
What you should do is maintain a diversified portfolio that prepares you for great long-term returns and wealth preservation.
Any reader who has taken our advice about portfolio construction is already prepared for a wide range of outcomes in the financial markets, including the possibility of an extended bear market.
We’ve been advising readers here, in the Stansberry Digest, and on the Stansberry Investor Hour podcast to hold a “truly diversified portfolio,” which contains four core elements.
- Stocks (50% or more of your liquid assets)
- Plenty of cash (20% or more)
- Gold and silver (10% or more)
- A small amount of bitcoin (5% or less)
The percentages are suggestions. They don’t add up to 100% because there could be other assets you might want to include in your portfolio, like real estate, art, or other stores of value that you know well. Only you know what kind of investor you are and what makes sense for your personality, risk tolerance, and goals.
Investing style and asset allocation is a personal decision and requires experience and self-knowledge. So we won’t predict tops and bottoms. But we will help you stay diversified, including keeping a steady stream of new equity ideas flowing into the stock portion of your portfolio.”
I thought the above advice was truly incredible! As for ourselves here in our household… we are like, and these are rough guesstimates, not actual calculations, (I could take the time to get some exact numbers, but it doesn’t strike me as being worthwhile) some 24% in stocks, maybe 18% precious metals in all its forms, nearly 40% cash, some 12% in cryptos, and some 6 or 7% maybe in a commodity trade in Iridium. This all comes out to around 100%. Maybe I’ll do the hard work of figuring it all out to the 10th of a %, but I’m just too busy at this time.
Harold F Crowell