Before I begin this stim-winding commentary, look to your right at the top of the page. If you would, enter your email into that box. In the near future, I will inform you of new posts hitting this blog and other useful content for traders and investors. I have one more mea culpa too. I have one very minor software glitch related to output and NOT related to neural net software that prevents my posts with the familliar Daily Reversal Report format. It should be ready by Wednesday. I will keep the sole survivor that met the screening criteria perhaps for commentary tomorrow once I get the little problem fixed, but this one is simple. Now, lets get back to the subject of valuations!
I have heard all the commentary from every talking head of every persuasion (political, long/short, bearish,if those really exist in the current environment, and bullish. I have for at least 2 years been skeptical of U.S. equity valuations, and I am not ashamed to say so. I was fortunate, though I had some hunches about forward economic activity, to have gotten rid of all of my energy names before the beginning on 2013. I was a little early, of course, but I had held those positions since 1987 (yep, bought some after the crash of 1987). I was concerned not so much by the Saudis trying to crash America’s oil shale development party. I was really worried about the pace of economic growth in the USA.
I understand that my critics (and I have had many comment to be about it in emails) get made at me when I reference the Shiller P/E index, which stands as of this writing at 27.2, near the peak of the last market rally (into early 2008). The reason I like this measure is that is is inflation adjusted and is compared to nearly 130 years of U.S. market data. It is not just a short-term measure. It does bother me that, as it approaches 30, it gets close to the extreme values not seen since the 1929 crash and the 2000 dot-com bubble. I have written about this countless times on this blog, so I will not beat this horse to death.
What I want to add to this discussion, however, is the following chart from dshort.com, which is the Advisors Perspective website. Take a look at this chart, which is an average of vour common valuation indicators (including the popular Q Ratio, and the S&P Composite Index distance from its regression line. The average of all four is at 92% above their median or regression line values. The most conservative one (and one I think that is highly accurate) the Crestmont P/E is out 110% and the Cyclical P/E 10 is at 77% above its mean. It as room, if one believes it can eclipse the dot-com bubble levels (and some out there think it can), but as one can see, the S&P 500 is stretched dramatically beyond its mean values over history).
What should also concern investors (particularly long only investors), is that consumer and business spending is slowing. U.S. GDP and corporate earnings are also slowing more than expected. If the Bureau of Economic Analysis data is correct, people are spending whatever they are saving on lower energy prices ( beacuse of the oil glut and slowing economic activity around the world ) are either attempting to save the money, buy other insurance, or spending it on medical expenses, including the Affordable Heathcare Act insurance premiums. Since insurance and financial services are a form or forced or disciplined saving (and who knows what it is if it is drawn into the Federal spending vortex), a vast majority of that money is NOT being used for discretionary spending, and that too can be a drag on the US economy. Add to that the U.S. dollar index near multi-year highs, and multinational US corporations have a hard time exporting for more profits abroad, and that is a drag on earnings. While Eurozone currency weakness (the weak Euro) will aid their economy , the rest of the world, including China, is cooling off.
So you must be asking yourself, what is David Buffalo’s payoff in writing all of this?
Here it is: If you are a long-term long only investor, and you want to follow Warren Buffett’s mentality in this, you must follow his first rule; “DON’T LOSE MONEY!”
What in the world does THAT mean?
If you have a diversified portfolio, you should look at each holding, particularly if you have held something for longer than a year-and-a-day (so as to trigger long term capital gains and not short-term capital gains) and decdied on an future earnings estimate to value basis if the stock is too expensive. If it is, and you are not collecting dividends, you should likely sell that position and raise cash. If not, you might want to consider hedging the position with options to ride out a potential correction (something that happens during or just before a major economic slowdown) and protect your equity position. When the market corrects, and ultimately IT WILL, you will have a cash position avaialbe to purchase equities at bargain basement prices. CASH IS A POSITION. It should be held when things get a little squishy on the trend side and crazy on the valuation side (when it comes to stocks).
Am I telling you to go buy your canned goods, ammo, water, and to go dig your bunker, never to come out again until nuclear winter ends? NO. I am telling you to use your head and not let profits get away that can be redeployed, and to get rid of assets that are failing badly (another way to reduce the tax bite from your winning investments).
We are in a period of world instability (and not just with currencies, but with all kinds of crazy world events from Russia to the Middle East and hundreds of other places. When interest rates are at zero, fixed income investments look like cow patties and virtually everything else shines like a diamond, even though that alternative investment may eventually be a warm cowpie itself. THINK BEFORE YOU STINK (at holding onto overpriced or failed investments). Be level-headed and proactive, and you will ultimately win the investment game.’