When will the sky fall?

Now before you get all snippy about my negativity let’s get something straight, everyone has their own opinions about the markets and what they selfishly want to see them do. For me it isn’t that I want to see people that are long in the market lose money, I mean I am long with equities in about half of my portfolio. The market at its current evaluations are simply just too high for me to be a buyer with a majority of my money right now. That being said, there are a few companies that I think are at a buy/add/don’t sell price for me.

First The Market

While trying to time the market is a fool’s errand, especially an amateur fool like myself, there are some things that I like to keep an eye on and guide my investment process with. First off there is the Buffett Indicator. For those that are not familiar with the Buffett Indicator let me break it down:

The Buffett Indicator is a ratio that is found by dividing the total market cap by the value of the gross domestic product. In other words, how much is our market being valued in comparison to how much product value is being created in our country.

Where are we right now? Take a look:

Taken from: https://www.gurufocus.com/stock-market-valuations.php

Taken from: https://www.gurufocus.com/stock-market-valuations.php

Recognize anything familiar? How about the sizable drops that were sustained in the market when we got too far out of balance. While I’m not saying that a crash is inevitable, what I am saying is that the gap between the market value and GDP is way out of my comfort zone to be making a lot of large purchases. As of writing the Buffett Indicator is 139% which, according to the researchers at gurufocus.com, is significantly overvalued (anything over 115% is considered to be at this level). What then is historically normal? The same researchers show a value between 75-90%. That’s a 50-65% corrrection!

Now I’m not saying that the market is going to fall off by that amount but I am saying that extreme caution has been added to my vocabulary over the past year.

Another ratio that everyone should be aware of is the Shiller P/E Ratio. What is it? Here’s a quote from gurufocus:

Prof. Robert Shiller of Yale University invented the Shiller P/E to measure the market's valuation. The Shiller P/E is a more reasonable market valuation indicator than the P/E ratio because it eliminates fluctuation of the ratio caused by the variation of profit margins during business cycles. This is similar to market valuation based on the ratio of total market cap over GDP, where the variation of profit margins does not play a role either.

https://www.gurufocus.com/shiller-PE.php

So what does this all mean? Well it means that we have another tool to use and guide our aggressiveness, or conservatism, in the market as a whole. The Shiller P/E has a historical mean of 16.9 which right now looks minuscule in comparison to the current ratio of 30.6 (as of writing). Yes that’s almost double! Again another ratio that is also projecting we are about 50% from the so called norm.

In historical chart form:

Taken from: https://www.multpl.com/shiller-pe

Again we see the market getting out of whack and being corrected. Obviously the corrections come over time, sometimes shorter than others, but what we can assume (dangerous word) is that returns when we are well above the norm are not going to be great IN THE OVERALL MARKET.

This leads me to the third thing that I watch as I continuously analyze my portfolio. While charts are easy to read, this is a bit different, Guru’s holdings.

What guru’s you look at do make a difference. For me I like to look at value based guru’s that hold the the same philosophy as me, and honestly the ones that I learned investing from (not in person of course).

The top three that I watch:

  1. Warren Buffett
    Of course this is number one on the value investing watch list. There has been no one better to learn from than the Oracle of Omaha and I don’t plan on discontinuing my spying.

  2. Mohnish Pabrai
    If you are an aspiring investor and you don’t know Mr. Pabrai then shame on you. His book The Dhando Investor is a goldmine of information on the correct way to invest in the market. Go get it, read it, then read it again.

  3. Seth Klarman
    Another man that has made his way to the value investing Hall of Fame. Mr. Klarman who wrote Margin of Safety, a book no longer in print (but can be found on Amazon for ~$900) is another great investor to learn from and watch.

Now before you let me have it for not having your favorite value investors in my list realize something: this is MY list. This doesn’t mean that these men are the only good value investors but it means they are MY favorite to keep an eye on and learn from. Everyone’s journey is very unique and people learn differently.

All this being said though, there is something that all of these men have in common:

Outstanding annualized returns over long periods of time,

AND….

All currently seem to be setting up for a market crash/crisis/recession in the near future.

Don’t believe me?

How about Seth?

"It can't be business as usual amid constant protests, riots, shutdowns and escalating social tensions," Klarman wrote in the letter, reports CNBC, which also warned that rising levels of debt taken on by major countries (including the US) could be planting "the seeds of the next major financial crisis."

—Taken from https://www.cnbc.com/2019/01/23/why-baupost-groups-seth-klarman-is-called-the-next-warren-buffett.html

Or Warren?

Well without going into grabbing multiple quotes, Mr. Buffett has stated on many occasions that the market is just too expensive right now for Berkshire Hathaway to buy much. He is currently sitting on the most cash that he ever has and is waiting for things to come back into a range where he can make a large purchase.

Still not convinced?

Well what if I told you that Mohnish Pabrai, a man that made his fortune by waiting patiently and making large bets on companies that he believed is severely undervalued, is holding just TWO positions at the moment (in the US markets). This is a guy that historically in recessions holds around 15-20 and other times about 6-8. Until recently he hadn’t purchased a new stock in almost 2 years! That screams that the market is overpriced!

So what? Maybe these guys are wrong right?

Yeah maybe they are. Maybe three of the most well respected value investors agree that the markets aren’t currently at values where they would sink large sums of money into it. I think I am going to follow their lead though.

my portfolio changes

To be short, my positions went from 18 to 8 (6 of which being stocks).

But before you call me Chicken Little and think that I am nuts, realize that this was a long time coming and honestly something that i should have done last year at some point. Many of the companies that I was holding were what Buffett would call “cigar butts” and I was lucky enough to take a puff, choke on it in December, then get it back (and some) over the last few months. Not many of these companies were ones that I wanted to own forever so now that I believed that they were overvalued I needed to take my profits and move on.

Where am I now then?

You can take a look at the full portfolio as always here, but my current portfolio is sitting at just over 50% equities, about 40% bonds and just over 10% cash. Being patient and waiting is what I am going to get really good at and the 5 positions that I currently hold are ones that I believe are either fairly or undervalued.

I will go into each of these in my next post because this one has gotten way too long for my taste and I don’t want to lose everyone’s attention. Until then I wish you all well and hope the best for your investing.