Dear Reader,
Two pieces of information came out prompting me to issue a market warning and share with you our plan.
First, the Buffett Indicator is now at its highest point in history.
The Buffett Indicator measures market cap to GDP.
Warren Buffett famously said when it gets over 200% you’re “playing with fire.”
We are in a “playing with fire” stock market.
And we know Warren Buffett has been a net seller of stocks for 12 straight quarters, which is historic…
He’s never been a net seller of stocks for that long.
He didn’t even deploy any extra cash to buy Berkshire shares, which he likes to do when he thinks his own stock is a bargain.
Now, this Buffett Indicator warning comes at the same time we see another valuation measure is pointing to some rough years ahead.
For the second time in history, U.S. stocks have crossed a valuation milestone, which is the cyclically-adjusted price-to-earnings ratio.
That’s something people like me are very focused on.
Because when you look at any company’s P/E for one year, you can see a lot of distortions in that.
A company could take a write-down, or they could have a super good year. A lot of things could happen in any one year that won’t reflect the earnings over time.
So I look at average P/E and average earnings for the prior 10 years-plus…
What that shows me is the average earnings capacity of a company in both good and bad economies and markets.
Members of Takeover Targets will remember very clearly that in April when the market crashed and I came out with that Buy List I sent them that Sunday night…
What I did was I used the 10-year average P/E, because again, it shows us what the average P/E should be, what it’s been over a few economic cycles - expansions and contractions.
Very important - much more accurate than a one-year P/E.
You’ll remember getting into Meta at $486, and all these things.
And now, the Shiller’s CAPE model shows that stocks are in nosebleed territory.
They haven’t been this expensive since the dot-com bubble.
These measurements go back to 1881, but back then the U.S. was more like an emerging market, after the Civil War and stocks were very widely manipulated. It was crazy.
You really want to start in 1990.
Now, these two metrics are part of the bear argument - that stocks are very, very highly valued.
But here’s the counter argument - because we can’t engage in magical thinking…
We have to look at the facts as they are.
We try to understand that P/E ratios today can be higher, naturally, than they were 20 or 30 years ago.
Why is that?
Because companies today sell across the globe and have higher-margin businesses.
You think of manufacturing in the ‘80s when we made hats and t-shirts - those are low-margin businesses.
Now our most-valuable companies are high-margin businesses. They sell software.
So instead of getting a 5% return on your capital, you get a 30% return. So you should get higher P/Es - no doubt about that.
There’s a very solid argument for the market having naturally higher P/E ratios than in the past.
So, we don’t want to go back to 1950 or 1960 when we’re looking at the 10-year average inflation-adjusted P/E.
I’d only look back as far as the ‘90s, when we started to see computers and software selling - Microsoft, Amazon, eBay and all these other high return-on-investment businesses.
Since then, the average P/E has been around 27.
So, at the end of the day, we have a situation here where we are now well above 40.
Before the dot-com crash it was 42.
This is one of the reasons we see people shorting stocks like Palantir and Nvidia.
Michael Burry, famous for predicting the 2008 housing crash, has been warning that the AI boom looks very similar to the dot-com boom.
But now, he recently revealed that his firm, Scion Asset Management, has a billion-dollar short position - bearish options position - against both Palantir and Nvidia - two of the biggest winners from the AI frenzies.
We’ll see how this all plays out.
I learned never to short because the Tisch family went short in the nineties during the dot-com bubble.
The stock market kept going higher, valuations were obscene, things were stupid and everyone knew it.
1996, ‘97, ‘98 he kept going short, losing billions and billions.
He was right on valuation - things were definitely overvalued.
He was wrong on timing.
A crowd can stay insane for long periods of time.
So, what we don’t want to do in situations like this is take short positions like the Tisch family did.
We don’t want to bet on when the collective flock of birds that is the stock market suddenly decides to turn left or right.
We want to go with the flow, but keep an eye on the exits.
We want to stay alert, understanding the market could change quickly.
In Takeover Targets I employ my favorite strategy for bringing in consistent gains through bull and bear markets alike.
Since we launched in January 2020, we’ve seen a near-100% win-rate on all closed positions…
Through the Covid-crash… the 2022 bear market… in good times and bad, this strategy has knocked out gain after gain, buying and selling regular stocks.
See how it works right here>>>
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