This post A Looming Crash is Near… Check Out the Cold, Hard Facts appeared first on Daily Reckoning.
The markets aren’t always peaches and cream.
Long-term trends consistently lead to positive returns, but the occasional bear strike is always waiting to cripple returns and cause investors to run for the hills.
While many analysts are predicting the S&P to run higher over the course of Trump’s presidency, not all are optimistic about the future of the stock market.
One such analyst is Jody Chudley, who gives his take on current market valuations and offers a solution for protecting your wealth when uncertainty comes near.
I’m going to cut right to the chase. This week, I intend to scare you.
I’m not talking about the monster in the closet… I’m talking about something much more sinister that is stalking you:
If 100 years of history is useful as an indicator, you need to quickly become aware of what lies ahead for the U.S. stock market. Spoiler alert… it isn’t pretty, and we all need to get our portfolios prepared for it.
High Valuations Are Running Rampant
I hope you like charts and data, because I’ve got a few graphics for you that I think anyone investing money today should see.
Let’s start with some market valuation work that Goldman Sachs released to its clients this month:
Goldman Sachs — S&P 500 Valuation
Goldman looked at the current valuation of the S&P 500 across seven different measures. On an aggregate (overall) basis, valuations look pretty scary. The market as a whole is currently sitting in the 88th percentile relative to where we have been over the last 100-plus years in terms of being expensive.
That should set some alarm bells.
When Goldman breaks it down to where the median stock sits, things look considerably worse. Across those seven valuation measures, Goldman finds that the median S&P 500 stock is in the 98th percentile!
The only valuation measure against which the market doesn’t look incredibly expensive today is against free cash flow. The only reason that stocks look OK on that measure is because interest rates are incredibly low, and as a result corporate debt loads aren’t consuming a great deal of cash.
Let’s move on.
Another chart, another reason to be concerned:
Market Capitalization to GDP – Buffett’s Favorite Metric
Back in 2001, Warren Buffett revealed to Fortune magazine his favorite tool for measuring how expensive the S&P 500 is. What Buffett likes to do is look at the total market capitalization of stocks versus the gross domestic product (GDP) of the United States.1
Take a look at the chart above and tell me if you think Buffett’s favorite indicator provides a valuable signal for investors.
The peaks in market cap-to-GDP take place in the following years:
If you are even a casually interested in the stock market, you have likely spotted the reason to be concerned. Every one of those dates preceded a pretty brutal stock market sell-off.
Which leads me to another graphic, this one prepared in August 2016. The graphic looks at the seven longest bull markets in history (the current bull run is about to become #2) and includes all of the peaks of the Buffett value indicator:
The column on the far right shows the pretty gruesome market declines that have taken place when the Buffett valuation indicator is flashing red like it is today.
Have I got your attention yet?
How about one more graphic… and it is a doozy:
Bank of America — S&P 500 Valuations
In early December 2016, Bank of America looked at the S&P 500 valuation across 20 different measures.
What Bank of America found is that out of the 20 measures, the S&P 500 sticks out as being overvalued on 17 of them. With that many data points showing the same thing, a person has to start to believe.
The percentage overvaluation of the S&P indicated by these measures is more than 20% for nine out of 20 of them. Some of the more widely followed measures are pointing to more than a 50% overvaluation.
The Importance of Corporate Bonds in Your Portfolio Has Grown
You might accuse me of being dramatic, but there is a problem with doing that.
Everything that I’ve shown you today is data. Cold, hard data without any spin on my part.
Maybe there are people who can look at all of those data and conclude something else. For me, though, it is very clear the S&P 500 is very expensive. Historically, when the market has been this expensive, what follows next is very unpleasant.
In my opinion, the only things that have held stock valuations up this high for this long are the absurdly low interest rates that central bankers around the world have created.
We see those low interest rates starting to slip away in the United States, and as those rates creep higher, things are going to get very interesting in a hurry.
One way to protect your wealth in a bear market is by owning corporate bonds. Even if the market completely collapses, the companies representing the bonds are still required to pay scheduled interest payments by law. Then on maturity, they also have to repay the entire face value of those bonds.
There is no contract in place when you buy a stock that stipulates that you are going to get your original investment back.
For the performance to maturity of corporate bonds, it isn’t going to matter what the stock market does. While stock market investors are pulling their hair out, bond investors can sit back, relax and keep cashing those contractually obligated interest and principal payments.
Bring on the bear!
Keep looking through the windshield,
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