Buffett Indicator & Shiller PE Ratio

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Over the last few weeks I’ve been setting Trailing Stop Loss Orders (TSLOs) for VTI, VOO, and SCHG when portfolios holding these securities come up for review.  The tariff wars are causing market uncertainty, but tariffs are not the only reason for setting TSLOs.  Erratic administration behavior only exacerbates an overbought market.

Yesterday I ran across this YouTube video which aligns with my current thinking regarding the U.S. Stock Market.  Avoid the advertisement around the eight minute mark.

A few readers may remember the period from around 1967 through August of 1982.  In the mid to late 1960s the Dow Jones Industrial Average (DJIA) topped 1,000 for the first time.  In August of 1982 it was below 800.  That was a lost 15 years of market growth and not a good time to retire if one needed savings to live.  From 2000 to 2012 was another fallow market period.  We may well be heading into another such period if we check out the Buffett Indicator and Shiller PE Ratio.  These two indicators are among the best long-term data sources when it comes to broad U.S. Equities behavior.  Neither is perfect, but none are as the market always behaves in an unpredictable fashion.

Buffett Indicator: 

Check out the above graph and look for periods around 2000 and 2008 or times when the market took a major hit.

“The Warren Buffett Indicator, also known as the Market Capitalization to GDP ratio, is a valuation metric that compares a country’s total stock market value (market capitalization) to its gross domestic product (GDP). It’s named after the famous investor Warren Buffett, who has used this metric to assess whether the stock market is overvalued or undervalued”

“This ratio fluctuates over time since the value of the stock market can be very volatile, but GDP tends to grow much more predictably. The current ratio of 211% is approximately 66.99% (or about 2.2 standard deviations) above the historical trend line, suggesting that the stock market is Strongly Overvalued relative to GDP.”

The recent GDG is negative, yet the market is moving higher.  Don’t expect this to continue.

Shiller PE Ratio

“The cyclically adjusted price-to-earnings ratio, commonly known as CAPE, Shiller P/E, or P/E 10 ratio, is a stock valuation measure usually applied to the US S&P 500 equity market. It is defined as price divided by the average of ten years of earnings (moving average), adjusted for inflation.“

“The CAPE ratio is a valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle.”

“The CAPE ratio, an acronym for cyclically adjusted price-to-earnings ratio, was popularized by Yale University professor Robert Shiller. It is also known as the Shiller P/E ratio. The P/E ratio is a valuation metric that measures a stock’s price relative to the company’s earnings per share. EPS is a company’s profit divided by the outstanding equity shares.”

“The CAPE ratio is generally applied to broad equity indexes to assess whether the market is undervalued or overvalued. While it is a popular and widely followed measure, several leading industry practitioners have called into question its utility as a predictor of future stock market returns.”

I am more familiar with the Shiller PE Ratio than I am with the Buffet Indicator.  If an average Shiller Ratio is around 15 to 17 and it is currently bouncing around 35, this is an overbought market.

What To Do?

• One option is to hold on to current securities, continue to save and place all savings in a short-term treasury such as SHV.  If one were to take a tax hit by selling securities, this option makes sense. Build cash reserves and wait for the next buying opportunity.
• A second option is the one I am applying to a number of portfolios and that is to set TSLOs on holdings such as VOO, VTI, SCHG and other equity oriented securities.  New cash and dividends are reinvested in a short-term treasury ETF.

I don’t see an overbought market impacting the Sector BPI portfolios or the Robo Advisor account, Copernicus.  The Sector BPI portfolios are designed to operate in a volatile market whereas the Copernicus is manage by computer.

Regardless of the investment strategy, now is a good time to continue to save and build up a cash reserve in a short-term treasury such as SHV.  Collect the 4% to 5% interest rate and wait for a market draw-down.

Lowell

Comments and Questions are always welcome.