Back in 2001 Buffett said in an interview with Fortune Magazine that “the single best measure” of stock market valuation is by taking the total market cap (TMC) and dividing it by the total gross domestic product (GDP). Today TMC is equal to 114.5% of total GDP.
At the market top in 2007, just prior to a -54% crash in stocks, TMC was equal to 104.9%. According to Buffett’s “favorite” market timing indicator stocks are more overvalued today than in 2007.
What’s more, since the Market low in 2009 when the ratio was at 56.8% and was the first time in 15 years that stocks were truly “undervalued”, the ratio has climbed for six consecutive quarters and is now nearly two standard deviations above the mean.
Chart provided by dshort.com
Annotations of the 2000, 2007, and todays potential top added by directionalerts.com
Will stocks crash soon?
That’s a difficult question to answer, but here are some additional things to consider, which argue in favor of caution:
1. Corporate profit margins are at an all-time high yet earnings are stagnant. The S&P is currently pricing in earnings expansion, but without meaningful earnings growth it’s not sustainable.
2. According to the American Association of Individual Investors, stock allocations have reached 66.9%, which is near it’s highest level since September of 2007 just one month prior to the peak and a -54% crash.
3. The Shiller P/E (cyclically adjusted P/E) is at 25.8, almost double it’s historical average of 16.5.
Timing the stock market is not easy, however, we have come a cross a unique timing tool that is completely free and has accurately predicted 22 of 24 major market turns since 1970. That’s an astonishing 91.6% accuracy rate.
In fact, it said to sell stocks and move to cash in both 2000 and 2008 saving investors the agony of watching their savings vanish during both the dotcom and real estate busts.
This tool then said to buy stocks in 2003 positioning investors to profit from a market that would rise 59% before warning investors to move to cash in order to avoid the 2008 meltdown.
It then signaled investors to buy stocks again in 2009 where they could have enjoyed a 79% rise through today’s current level.
Imagine how much closer you would be toward your retirement goals had you moved to the safety of cash during two of the worst market crashes in history, then bought back into stocks near both bear markets lows.
You would have trounced a buy-and-hold approach which gained a measly 2.3% per year over the same 14 year period…..not even matching true inflation.
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