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The Broader Stock Market Is Overvalued: Slightly to Significantly

Buffett Indicator
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Stock analysts across the globe are constantly scouring the broader US stock market to find securities that may offer value investors a genuine opportunity for long-term investment.

Recently, however, most analysts are encountering the same problem: most stocks are overvalued, if not slightly, then significantly.

Adding to the problem is not only the fact that stocks are overvalued relative to one another, but that such valuations are enormously high when compared across the entire history of the US markets.

Take a look at this chart of historical S&P 500 PE Ratios since 1870:

Not only is the average stock 74% above the mean, but there were also only two times when this has happened before: in 1929 and 1999--before the Great Depression and during the Dotcom Bubble.

Here is another chart, the “Buffett Indicator,” that Warren Buffett uses to gauge market valuations. This chart is like a price-to-sales ratio for the entire US economy:

Taking the entire market value and dividing it by the GDP, it shows us that we’re not quite at the excessive 1999 levels yet. But it also tells us that stocks on average are now very expensive.

Another important measure of equity value which you might be less familiar with is Tobin’s Q Ratio. According to the theory, a company’s market value should be equal to its “replacement value,” or the value of its total assets.

When the market value exceeds replacement value, the company is then seen as over-valued. As you can see below…

Similar to the last two charts, stocks are expensive, their overvalued levels having been exceeded only once since 1900.

There is not one indicator that has consistently or accurately pinpointed the onset of a recession. But historically, almost every recession has been preceded by stock market declines.

The question every investor should ask is how one can invest “safely” when the broader stock market is significantly overvalued, and when a major stock market decline, or a recession, may be just around the corner.

Naturally, this is something that every investor is concerned about. Some experts will argue that equities are overvalued while some experts will say that they can move higher in this low-interest environment.

Apparently, the Fed sees continued growth and are willing to hike rates above what they consider the “neutral rate of interest,” or the rate at which interest can neither encourage nor hinder economic growth.

But the Fed has also removed much of the language on “accommodative” approaches to interest rates, admitting that they are not entirely certain as to how they are to measure the neutral rate.

So how are “experts” able to assess the valuation of stocks when even the Fed is uncertain about the neutral rate of interest? Lot’s of confident talk from experts whose essential message is nothing more than speculation.

But the point is not to predict the turning point of either the markets or the economy. The point is to be positioned for financial security and growth, come what may.

If you are facing a dilemma, worried that you may miss out on more stock market gains (despite overvaluation), or worried that you may lose those gains if we enter a bear market, worried about missing out on fixed-income gains, or worried that inflation may eat away at the purchasing power of your assets, then you might want to consider allocating your portfolio for an all-weather scenario.

25% stocks, 25% bonds, 25% cash, and 25% gold. Not only is this a conservative approach to asset allocation, it is also the only model that has successfully weathered all recessionary and inflationary environments since before 1926.

Remember, you cannot control the markets. But you can control your portfolio. And if you truly wanted to invest conservatively, then you would prepare for any market environment by using an all-weather allocation. There may be no “safer” nor “smarter” way to invest.

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All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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