The stock market seems to only be able to go up as of late and there are a few indicators that suggest stocks may be overpriced.
One such indicator is what is sometimes called the “Buffet indicator”, a reference to legendary investor Warren Buffet who first popularized this metric. This indicator compares the value of all the companies on the stock market of a certain country and divides this number by the value of all the goods and services that this country produces.
The Buffet Indicator = Market Cap / GDP
Looking at where the buffet indicator stands today, the chart is quite scary. We can see that we’re at a 156.3% ratio which is near the level it was at before the dot com bubble burst in the beginning of 2000.
If you look at the P/E10 Ratio which looks at the Price of stocks and divides it by the earnings over the last 10 years (to account for cyclicality and moderate the effect of extreme events such as the pandemic that we are experiencing), we’re currently at the 94th percentile of the P/E10 Ratio.
As scary as these charts look, timing the market remains a fool’s errand. When a correction will occur is anyone’s guess. It could be tomorrow, after 6 months, a year or two, who knows. However, I do think that this is a time to be careful. So here are some tips for navigating what appears to be an expensive market:
1- Don’t get greedy.
If you think the valuation of a company has run amuck and reached a level that you just don’t think can be justified by any fundamentals, time to take some profits. Don’t stick with an overvalued position hoping that a greater fool will come along.
When the music stops you want to make sure you’ve already sat down.
Remember: Bulls make money, Bears make money and Pigs get slaughtered.
Make sure you’re not the latter.
2- Don’t invest money you can’t afford to lose.
Make sure you have your cash reserve situation sorted out. You shouldn’t have cash you need for upcoming expenses in the market. Ever.
Many financial experts suggest a 3 to 6 months cash reserve at all times.
Probably not a bad rule of thumb.
Invest in more than one asset class.
Don’t park all your wealth in just stocks.
Make sure the asset classes you’re diversified across have low correlations with one another. So if a drop happens not all your investments drop together.
Good asset classes to diversify into include Stocks, Gold, Real Estate and if you earn more than 200K annually take a look at my investment fund BFF which offers an asset class that has displayed 0 correlation with the stock market since our inception in 2017.
Cryptocurrency is another asset class but I don’t think we have enough data on how correlated cryptos are with the market when things actually go south.
4- Educate yourself.
The biggest return for knowing what you’re doing is in case of a downturn.
When times are really good and the economy is thriving, basically everyone makes money.
However, when things get tough, people start to discover whether the stocks in their portfolio are true winners or were just riding a rising tide.
As Warren Buffet once said “Only when the tide goes out do you discover who’s been swimming without shorts.”
Not a Zabiha image but you get the point.
Innovative companies with good management, strong financials and growing markets will start to separate themselves from the rest of the pack most remarkably when the going gets tough.
Accordingly, the biggest return you’ll get for researching the companies you invest in, exercising discretion and being strategic will be in case of a downturn.
So if you have the interest and would like to learn more about researching stocks and investments now is the time.
I hope this blog will help you do exactly this.
Disclaimer: This article is not to be considered financial or investment advice. Don’t invest any money you can’t afford to lose. Make sure you do your own due diligence before making any investment decisions.