• John Hawver

Cassandra is no fun

Since the lows in December 2018, the market has rocketed back to where it was in October. It’s a “good” feeling, like relief. The factors that drove the market down, tariffs, the government shutdown, and especially the Fed continuing to raise rates, have all abated. Clearly, those driving the ship don’t want to be the cause of a true bear market, plus, they have a lot of their own wealth on the line.

What the powers that be may or may not realize is that they are standing on top of a very overvalued market. Multiple metrics show this. For instance, using a Tobin’s Q ratio (replacement value) the market is 25% overvalued. Using Warren Buffett’s favorite indicator, GNP to Market Cap, it’s even more expensive, roughly 50% overvalued. Shiller’s PE ratio show’s a similar reading at 29.65. Simply put, the equity market is expensive.

The standard safety asset for expensive equity markets is US Treasury Bonds. So, are bonds cheap? Using equity risk premium calculations, equities actually look slightly cheaper relative to bonds, if compared to the historical average.

By that relative logic, bonds are expensive too. Surprising? A bit, but considering the Federal reserve has 4 TRILLION dollars of bonds on their balance sheet, perhaps not. QE has caused vast swaths of assets to become expensive. This is not like the markets in 2000; stocks were expensive and bonds were a very reasonable alternative.

Being Cassandra is zero fun.

So, what’s cheap? Beauty depends on the eye of the beholder, and, of course, your risk tolerance. Cash is cheap right now. If you can park it in higher yielding (~2%) accounts, it isn’t terrible. Or short-term Treasury Bills, Buffett has been stockpiling them on his own balance sheet. Venturing a little farther afield, some Utility stocks look cheap, especially in today’s changing renewables market. And, along those same lines, if you have the expertise, MLP’s in the energy sector, which have been beat up due to tax changes and oil prices, look quite cheap.

Overall, most investors should just pause for a moment and consider the heights of valuation we stand upon and not get too giddy about the market recovery; trees don't grow to the sky. Right now, return OF capital is more important than return ON capital.