The Most Overvalued Market in 150 Years

[Money Trends with Andy Krieger]( Welcome to Money Trends! If this is your first time reading one of our issues, learn more about us [here](. And if you have any questions or comments, shoot us a note anytime [here]( or at feedback@andykriegertrading.com. The Most Overvalued Market in 150 Years By Andy Krieger, Editor, Money Trends The stock market’s euphoria continues as investors pour record amounts of money into the market, regardless of valuations. The following chart helps put the current market valuations in a clear perspective… [image] This chart tracks the monthly averages of daily closes for the S&P 500 going back to 1870. Essentially, it shows us that recent averages are 144% above the long-term trend. It includes 150 years of data, so it gives us an extensive analysis of just how astonishingly overbought the current market is on a relative scale. As you can see on the chart, the market has launched much further above the long-term trend than at any time since 1870. We have never seen anything like it, and I suspect we won’t see anything like it for a long, long time. The simplest explanation for this phenomenon is that investors are desperate for yield, and they aren’t getting much of that in the fixed income markets. Short-term rates are near zero, and long-term rates are under 1%. So insurance companies, pension funds, and others are really quite desperate to generate returns in their portfolios. I understand the desperation, but it comes at a cost. In fact, for investors jumping on the train at this point in the ride, the current situation is fraught with danger. I’ll show you what I mean below… along with the single wisest thing you can do today instead… This Time Is Different In [Friday’s Money Trends]( I showed you a concerning chart from Bank of America. It showed November cash levels fell from 4.4% to 4.1%. Now take a look at this next chart. It tracks inflows to global stocks. And, as you can see, we just had the greatest inflow over a three-week period ever… [image] As noted, I understand the logic behind the decision. Vaccines and fiscal stimulus are on the way, the world is generally peaceful, we have a new Treasury Secretary coming into office who may be the greatest dove in history, the Federal Reserve will support any market weakness with unending liquidity, and so forth. But now look at how things worked out in January 2018. We had record equity market inflows back then, too. And then the market dropped about 12% in two weeks… [image] Yes, the world was different then. The Fed had penciled in three rate hikes for 2018. It had also been selling off assets it had accumulated after the financial crisis a decade before. In wonderful puppet-like fashion, Fed chief Jerome Powell caved to pressure and reversed course after the sharp stock sell-off. The market stabilized, recovered, and then started its climb to new all-time highs until the pandemic hit. So how different are things now? I would say they are very different, but not in the way you might expect… Recommended Link [TONIGHT: Jeff Brown Reveals The #1 Private Biotech for 2021]( [image]( The man who picked the #1 stock in the S&P 500 three out of the past four years… Is stepping forward to share details of his #1 private biotech of 2021 for free. It all happens tonight at 8 p.m. ET during “[The Cure Event]( [CLICK HERE TO RSVP NOW]( -- Nasdaq 5,000? To show you what I mean, let’s turn our attention to the so-called Buffett Indicator. It measures the total value of the stock market relative to GDP. And it’s the best single measure I know of to accurately gauge where a market’s valuation stands. The chart below is the St. Louis Fed’s version of the Buffett Indicator, indexed to the fourth quarter of 2007… [image] You can see the indicator is higher today than it’s ever been over the past five decades. The level is a very strong warning sign of an upcoming market crash. In fact, even if the GDP surges for years and the stock market goes sideways, the overvaluation is flashing red warning signs unlike any we have ever seen before. The indicator, however, is not useful for timing… And in certain ways it may be a more accurate measure of investor psychology than anything else. But consider a different metric… Since 1947, the average S&P return has largely tracked the growth in GDP. This makes sense, since GDP is largely driven by consumption. But in recent years, that trend has changed dramatically. To give you an example, let’s look at the past four years of growth in revenues for technology companies (the hottest industry sector in the S&P 500). The average compounded growth of revenues in this sector comes in around 12% over the past four years. And keep in mind, I am being generous here by using revenues as a benchmark instead of net earnings. In any event, by the same measure, the compounded annual growth rate of the stocks in this sector has been around 35%. Even if stocks on the S&P Information Technology sector were to drop by 50%, they would still be dramatically overvalued by this measure. And I’m not the only one sounding this kind of warning. Societe Generale, the French bank, recently did some analysis of the U.S. equity markets. They concluded that 57% of the current market price levels can be explained by the Fed’s quantitative easing (QE). The financial website ZeroHedge summarizes Societe Generale’s findings as such: The Nasdaq 100 has been the most impacted – and even more so this year – versus the S&P 600 Small Caps, which has been the least impacted. As of Oct-2020, the Nasdaq 100 price level was 57% explained by QE… Without QE the Nasdaq 100 should be closer to 5,000 than 11,000, while the S&P 500 should be closer to 1,800 than 3,300. The charts below help put this gap in perspective… [image] Image Source: Societe Generale via [ZeroHedge]( The reality is that we do have QE, so the asset bubble created by the Fed is of course what we need to consider. On the other hand, the relationship between profit margins and stock market returns are mean-reverting. That means that, over time, they tend to move back to their historical average. In fact, here’s what Jeremy Grantham – a British investor who is quite famous for predicting the bursting of three major bubbles – said: Profit margins are probably the most mean-reverting series in finance. If profit-margins do not mean revert, then something has gone badly wrong with capitalism. There is something wrong with the system and it is not functioning properly. It Pays to Wait The bottom line is that the detachment of the stock market from underlying profitability almost guarantees poor future outcomes for investors. The other conclusion here is that, given the vast distortions in the markets, something is very wrong with the system. Does this mean we are definitely going to have a big market crash? No. Is it highly likely? Yes. Should we expect negative stock market returns on average over the next 10 years? Yes, but with one caveat… If the absolute best case in our country’s economic history plays out over the next decade… AND valuations remain way above the historical average… we might see some average positive returns in the market between now and 2030. Still, they will be very low, even under the best of all possible scenarios. So what is an investor to do? As painful as it might be to sit on cash or not earn any sort of decent return, now is one of those times when it’s the wisest thing we can do. I believe that, by waiting, you will be much better off over time given the extreme stock market valuations today. Regards, Andy Krieger Editor, Money Trends --------------------------------------------------------------- Like what you’re reading? Send your thoughts to feedback@andykriegertrading.com. READER MAILBAG As Imre [digs deep into Elliot Wave Theory]( one Money Trends reader sees a golden opportunity… That sounds great! I am particularly interested in wave/triangle analysis on BTC (to determine the best time to buy more!) Thank you. – John T. Meanwhile, another lays out his feelings following [Andy’s warnings of a coming volatile market…]( I think you folks do a wonderful job in laying out your views. I read other letters and they are rosy to the brightest shades of red. Who is an investor to believe? The best condition for melt up, the economy and markets to tumble? Thank you very much. – Marc H. F. Have you used Imre’s Wave Theory tools in your own trading? Do you agree with Andy’s worrisome picture for the economy? Write us at feedback@andykriegertrading.com. 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