What’s on your mind for investments in 2020?
Simply put, that the U.S. stock market might be over-valued.
How might we know that? There are two metrics that are commonly watched that are telling us that may be the case.
This metric is lovingly known as the “Buffet Indicator”, as it is one of Warren Buffet’s favorite things to consider when making investment decisions. This chart represents a comparison between two things. One is the dollar value of all of the companies in the U.S., as measured by their stock prices. Two is the dollar value of our economy, as measured by our Gross Domestic Product.
You would rightly anticipate these two to run relatively in sync with each other (it's hard to imagine the average company being worth the most it ever has if the economy is doing poorly, and vice versa). So when they're not in sync, it might be time to take notice. As the above chart indicates, at least by this measure, the U.S. stock market is as expensive as it has ever been.
Something to consider here, is that with globalization, companies that are headquartered here in the U.S. are less and less dependent on sales within the U.S. Coca Cola, for example, derives just 36.7%* of it's revenue from sales within the U.S. So in effect, how the U.S. economy is doing really may not have much bearing on it's stock price / value.
So, one of two things is happening.
Either globalization is causing the historical relationship between a company's value and the state of it's local economy to break down, or two, this is just another case of investors (me) trying to figure out why "this time is different", which the late Sir John Templeton quipped are the four most expensive words in the English dictionary. In other words, we shouldn't go looking for reasons as to why this indicator is no longer meaningful, because it may still be.
This is another metric to consider; the "Cyclically Adjusted Price-To-Earnings Ratio". It simply compares the price of a company’s stock to how much the company itself is earning in income. Again, you would expect these to move relatively in sync (you wouldn't expect a company's stock to be soaring if their income is deteriorating). By looking back through time at this relationship, we can get an idea of when stocks were relatively expensive and when they were relatively inexpensive. This chart implies that we are currently in an expensive state.
I am not sharing these charts as a prognostication of a market decline, or to prompt any drastic changes to your portfolio.
My intention here is to keep you informed of some key aspects of the market and what they could mean, so that if a decline does happen, we can be prepared to stay the course, and you can achieve a higher return and thusly your goals, just as you did during the market decline of December 2018.
A good rule of thumb is that if your financial situation or goals haven't changed, your investment plan probably shouldn't, either.
I appreciate your time, trust and wish you a blessed 2020.
C Garrett Moore
Moore Financial Management, Inc.
Past performance is no guarantee of future results.