Monthly Outlook: October 2024
Stocks and Bonds continued to trend higher in September and have proven to be more resilient than many naysayers predicted. Stocks dropped 9% in August but came right back. Then stocks dropped 4% in September and, again, came right back. Nothing seems to kill this bull market party, at least not yet. This kind of market behavior (slip, and a save!) tends to make investors falsely confident, willing to hang on, and even buy more. Stock market bubbles always feel good, almost by definition, and we’ve been developing a bubble for the past year or two. That’s how we get to 100-year peak valuations like we have today. Similarly, parties (I’m told) are always raging and the most fun late into the night. But it rarely ends well for those who stay too long. Might this stock market party be raging well past midnight already?
The Disconnect Between Markets and Economics
On the one hand, stock markets are near all-time highs and have generally trended higher for most of the past two years. If one only looked at prices, they’d ask, “what’s not to like?” And now interest rates are declining, which makes it easier to borrow, providing further stimulus. It’s understandable why many investors are content to do nothing but hold on and hope for more. In Colorado, we have an expression “the warm before the storm.” Often, just before a major snowstorm, it gets warmer with blue skies and sunshine. Locals know to enjoy it, but to find your snow shovel!
On the other hand, economic data clearly shows a strong, but slowing, economy. Unemployment is rising, house prices are sagging, car sales are softer, and consumer confidence is down. The Federal Reserve board is concerned enough that they’ve started to cut interest rates. And we have critical elections in just 35 days. The yield curve is steepening again, as a result. When taken together, these economic indicators have accurately foreshadowed a recession and bearish stock market within six months on eight separate occasions over the past 50 years. And they’re flashing again, today. Sure, they could be wrong this time. Sure, the Fed might actually stick the “soft landing” for the first time in 50 years. And sure, the stock market and economy might continue to grow and expand for years to come. Let’s hope for that. But the economic indicators are suggesting that we might be closer to the end of this party than the beginning and it’s surely prudent to consider the next phase and get prepared.
Valuations are at Bubble Peak Levels
Valuation metrics aren’t very useful for short-term market predictions. But they’ve been closely correlated to long-term forward returns, as in 10-12 years forward. There are many valuation metrics that you’ve heard of including price-to-earnings, price-to-sales, etc. One of the best valuation metrics is often called “the Buffett Indicator,” because Warren Buffett uses it, and it is the “Total Market Capitalization to GDP” (TMC/GDP) ratio. It’s basically the value of all stocks divided by the value of the whole economy. Today, TMC/GDP is at 3.4x, which happens to be the highest level of the last 100 years! Other peaks that were close were 1929, 2000, and 2007. Correlating 100 years of TMC/GDP ratios to actual 10-12 year forward stock market returns, we would expect the next 10-12 years to provide negative stock market returns. You read that right: history suggests the markets will be flat or lower 10-12 years from now. Of course, it doesn’t say how we get there and, historically, we’ll see up and down markets along the way that we can profit from. Incidentally, 100-years of history also shows us that low TMC/GDP ratios of about 0.7x (compared to today’s peak of 3.4x), like we had in 1932, 1945, and 1983, led to 10-12 year forward returns of 16% to 18% per year. Corrections bring opportunities!
How To Invest Today
Stocks and bonds are trending higher and might continue to move higher. But economic indicators and valuation metrics strongly suggest that we are “partying after midnight” and are likely to see a recession and market correction before too long. Our goal is to invest for growth, but always avoid “the big loss.” As we move into October, we’re still fully invested. But we’re watching stock price trends carefully for any new downturns, which will trigger our sell signals. We’re ready, willing, and able to sell stocks and move to protection mode when needed. It’s no time to buy & hold.