Beginning a month ago, the bull market in stocks began to show some hesitancy, even perhaps stalling out after a long post-pandemic surge that took stock prices far higher.
After many months without a correction of over 1 percent or 2 percent, the most popular technology stocks are finally showing signs of fatigue. The closely watched so-called Magnificent Seven— Alphabet, Amazon, Apple, Meta Platforms (formerly Facebook), Microsoft, Nvidia, and Tesla—appear to have reached a topping out point:
Source: CNBC stock prices
Diversification is the strategy of spreading your investments across various asset classes so that your exposure to any one type of asset is limited. This practice is designed to help reduce the volatility of your portfolio over time.
A diversified portfolio consists of a mix of complementary assets to reduce overall risk, including:
stocks from different industries and countries
bonds
other investments, such as commodities and real estate
diversification within asset classes
adding foreign assets to the investment strategy
What are the factors arguing for lightening up on stocks?
Market-Valuation Ratio
The Warren Buffett ratio is a market-valuation ratio. It is also known as the Buffett indicator, and it is the ratio of total U.S. stock market value divided by GDP. Warren Buffett called the ratio “the best single measure of where valuations stand at any given moment.” The ratio is like a P/S [price-to-sales] ratio, where the price is the total market cap of all stocks that are traded, and sales is the total gross national product of the country.
This ratio fluctuates over time because the value of the stock market can be volatile; but GDP tends to grow more predictably and is less volatile. The current ratio of 202 percent is approximately 63.27 percent (about 2.0 standard deviations) above the historical trend line, suggesting that the stock market is strongly overvalued relative to GDP.
Source: Courtesy of Rodd Mann; as of June 30, 2024
The Buffett indicator reflects the value of the U.S. stock market in terms of the size of the U.S. economy. If the stock market value is growing much faster than the economy, for example, then it may be in bubble territory. A market bubble is marked by unsustainable price increases unsupported by the underlying fundamentals. When it bursts, stock prices crash, causing significant and sometimes permanent losses for investors.
Price-to-Sales Ratio
The price-to-sales (P/S) ratio is a valuation ratio that compares a company’s stock price to its revenues. It is an indicator of the value that financial markets have placed on each dollar of a company’s sales or revenues. The P/S ratio shows how much investors are willing to pay per dollar of sales for a stock, and it is calculated by dividing the stock price by the underlying company’s sales per share.
A low ratio could imply the stock is undervalued, while a ratio that is higher than average could indicate that the stock is overvalued. One of the downsides of the P/S ratio is that it doesn’t consider whether the company makes any earnings or whether it will ever make earnings. So, it must be one measurement among several, not standalone (see S&P 500 Index chart below).
Source: DQYDJ [Don't Quit Your Day Job.com]
How to Tell If the Stock Market Is Overvalued
Look for the following signs:
Earnings growth slows down, but stock prices increase rapidly.
Shares are trading at high price-to-earnings ratios.
The dividend yield is low.
Valuation multiples are elevated.
Company insiders are selling.
PEG [price/earnings-to-growth] ratio is high.
The economic cycle is about to turn.
Earnings growth: The Magnificent 7 ’s lead in driving most of the S&P 500 Index’s earnings growth could soon come to an end, as analysts project earnings for the third quarter of 2024 will show slowing growth among the group, while the other 493 companies are expected to post the first growth quarter since the fourth quarter of 2022.
Price-to-earnings ratios: P/E ratios can be too high. A higher P/E ratio means you are paying more to purchase a share of the company’s earnings. A P/E of less than 20 times is considered “good” while anything higher than 30 times is considered “bad.” A very high P/E ratio may suggest that the stock is overvalued, while a low P/E ratio could indicate a bargain or a struggling company.
Dividend yield is low: The S&P 500 Index’s dividend yields appear close to the index’s long-run average yield of 2.91 percent.
Source: Birinyi Associates / Dow Jones market data
Company insiders are selling. Overall, insider stock selling has been higher than average recently. At its current level of 5.61-to-1, this ratio suggests that insiders right now are selling at 5.61 times as many shares of their companies’ stock—relative to how many they are buying at prior market lows.
PEG ratio is high. The price-to-earnings (P/E) ratio gives analysts a good indication of what investors are paying for a stock in relation to the company’s earnings. One weakness of the P/E ratio is that its calculation does not consider the future expected growth of a company. The PEG ratio represents a fuller and more accurate valuation measure than the standard P/E ratio. Factoring in future growth adds an important element to stock valuation since equity investments represent the financial interest in a company’s future earnings.
A good PEG ratio is one that has a value lower than 1.0. PEG ratios higher than 1.0 are generally considered unfavorable, suggesting a stock is overvalued. Currently, the S&P 500 has a PEG ratio of 1.56.
The economic cycle is about to turn. The U.S. economy is showing mixed signals. While there are signs of cooling, as job creation is falling, the overall economic picture remains relatively stable. The unemployment rate has dipped slightly, and the economy continues to grow along with consumer spending. However, many Americans feel uncertain about the economic situation due to factors like inflation and housing prices.
Summary
The market may be at an inflection point. It has run up—for the most part—since we exited the financial crisis in 2008–09. During the dot-com crash of 2000, the Nasdaq Composite Index had reached 5,000—but fell hard. It took 15 years to get back to 5,000. But today, since 2015, in less than just 10 years, the Nasdaq has more than tripled! Caveat emptor—Be cautious!
Rodd Mann writes about carving out a creative and unique new career in a changing world. His own career has taken him all over the world, working in accounting, finance, materials, logistics and manufacturing operations. Author, teacher, writer, consultant, Rodd has worked in many high-tech roles.
Follow him here: www.linkedin.com/in/roddyrmann
![(Source: DQYDJ [Don't Quit Your Day Job.com])](/_next/image?url=https%3A%2F%2Fimg.theepochtimes.com%2Fassets%2Fuploads%2F2024%2F09%2F10%2Fid5721577-P0030910.jpg&w=1200&q=75)
Dividend yield is low: The S&P 500 Index’s dividend yields appear close to the index’s long-run average yield of 2.91 percent.
