Red flags waving….

Tuesday 11th July 2017

Red flags waving….

I make a point of keeping a close eye on the financial weather in the United States….

And there’s a good reason for that. The effects of what happens in the world’s largest economy – and its markets – are felt globally.

By keeping myself appraised of developments in the US economy and its markets, my intention is to be forewarned about – and forearmed against – what is heading our way in Britain….

  • Markets – blind or just complacent?

Stocks in the US and the UK continue to ride high – either at or within touching distance of the highest levels in market history….

Investors appear to believe that the bull market in stocks – which has already been rampaging for 100+ months – is going to keep on trucking….

But I disagree. I think investors should be preparing for a painful correction at best or a devastating crash at work.

I’ve been making my case for some time – catch up with the most recent coverage here and here and here….

With each week that passes more red flags appear. The market appears not to see. Either that or it does see but doesn’t comprehend or doesn’t care….

But at Money Truths we try to see things as they are – rather than how we might like them to be. And all the signs point to trouble ahead for market investors….

  • CAPE says US stocks are uncommonly expensive….

For example, consider one of our favourite indicators – the Cyclically Adjusted Price Earnings ratio or CAPE.

PE ratio is the price of a stock or a market divided by its most recent earnings per share.
CAPE differs from PE ratio in that it uses an average of 10-years’ earnings per share.

CAPE provides a more balanced and longer-term picture of earnings and, as such, is a better aide in helping you decide whether a specific stock or market is expensive or cheap….

Right now, the CAPE figure for US stocks is at unusually high levels. Last week it breached 30.0. The long-term average is 15.6. In other words, US stocks are almost twice as expensive as the historical average….

The CAPE index was devised by Yale University professor, Robert Shiller. Last week he issued a warning it will pay stock investors to heed….

‘The CAPE index that John Campbell and I devised 30 years ago is at unusual highs. The only time in history going back to 1881 when it has been higher are, A: 1929 and B: 2000. We are at a high level, and its concerning….’

It’s concerning because the great Depression of 1930s and the dot.com bubble and burst followed hard on the heels of the last two occasions the CAPE ratio hit such uncommon heights….

  • The Buffet Indicator says much the same….

The CAPE index is not alone in suggesting US stocks might be close to topping-out and falling back down to earth with a bone-shuddering bump….

Warren Buffet is one of the world’s most successful investors. He’s been the chairman and largest shareholder of Berkshire Hathaway since 1970….

Buffett uses a specific measure to help him take a view on the general health of US stocks. He looks at the ratio of market capitalization to GDP – the so-called ‘Buffett Indicator’.

That ratio hit an historic high-point during 1999 and 2000 – just ahead of the dot.com bust out. Right now, the ratio is not quite at that high-water mark. But it is not so very far away and heading very much in that direction….

Immediately after that last high point, Buffett warned investors that they are ‘playing with fire’ if they remain in the market at such times….

Buffett hasn’t issued any such warnings this time round. But you can be sure he is mindful of what his favourite indicator is telling him….

Stocks are expensive and heading into dangerous waters….

  • Euphoria is a ‘sell’ signal….

John Templeton, the renowned contrarian investor, made a point that is well-worth noting and bearing in mind….

‘Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.’

Applying that undeniable logic to today’s situation in US markets, now is a good time to be selling US stocks – because stock market euphoria is at a 6-year high….

That’s what the Bank of America Merrill Lynch (BAML) sell side indicator is telling us right now….

BAML analysts consider their sell-side indicator to be a reliable contrarian signal. It just rose 2.4% – and that could be a signal that the bull market in US stocks is finally running out of gas….

This last week from BAML analysts….

‘The recent inflection from skepticism to optimism could be the first step toward the market euphoria that we typically see at the end of bull markets and that has been glaringly absent so far in the cycle.’

  • Buy when the market is down in the dumps….

On the Templeton model, the time to sell is fast-approaching – if it hasn’t already arrived. And the time to buy will come around again when the market is at its most despondent and depressed.

It is at such times, when nobody wants to touch shares with a bargepole, that prices are low – enabling savvy investors with cash on hand to buy stock in fundamentally solid businesses at bargain prices.

Last time the markets corrected and took a steep dive back in 2008, it was the investors holding cash who were best-equipped to act quickly, snap-up bargains for pennies on the pound and position themselves to make big profits when the market started rising again.

Those investors were in at the bottom of the climb we’ve seen since 2009. The value of FTSE 100 stocks has more than doubled since. FTSE 250 stocks have more than tripled.

Those investors made the right move. They made the right basic play. Buy cheap when the market is depressed, sit-tight, hold and then sell when prices rise and acceptable gains have been made….

A few weeks ago, I highlighted a strategy that will pay dividends when the market is down in the dumps. If you missed that, you can review my thoughts here.

  • Going for gold….

But I’ll also be doing something else….

Early last week, Ron Paul – a former Presidential contender – went on record with his fears about an upcoming and panful market correction. He said this….

‘If our markets are down 25% and gold is up 50% it wouldn’t be a total shock to me.’

And he’s not talking about some indeterminate point in the distant future. He’s talking about this scenario coming to pass as early as October. Paul continued….

‘People have been convinced that everything is wonderful right now and that stocks are going to go up forever. I don’t happen to buy this. The old rules always exist, and there’s too much debt and too much mal-investment. The adjustment will have to come.’

It’s no coincidence that Paul links a correction in the stock market to a rise in the price of gold….

In times of trouble capital flees to gold – a traditional safe-haven investment – and prices can rise on the back of increased demand.

In a climate where there are plentiful signs that markets are heading for a fall, gold is a good place to have a portion of your capital.  Gold prices can be volatile, but gold can also be relied on to hold its value when other markets are struggling.

There are several ways to invest in gold. I’ll outline a few options next time….

That’s how it looks from here….

All the best,

 

Dave Gibson

Money Truths