If you’re normal, you don’t want to spend all your time studying markets, trends, stocks and the like. But if you’re rich, you need to be at least aware of these things to stay rich. Rich people don’t sit on cash—they invest. To do so wisely, they need to know trends to best preserve and slowly grow their assets.
It’s not impossible to get started in this world. It just looks intimidating because it’s numbers and there’s no set instruction manual for how to interpret them.
Consider this your first step. Here are three sets of data that are telling a very compelling story about the markets right now. This is relevant to you if you’re an investor in stock, crypto, or even real estate.
Buffett Indicator
Named after Warren Buffett, the investor-owner of Berkshire Hathaway, this is a broad market indicator for judging whether or not the market is overvalued. Buffett once called the measurement “the best single measure of where valuations stand at any given moment.”
The Buffett Indicator is a ratio comparing US GDP to the total stock market valuation. GDP is a very rough estimate of how productive a country is. The stock market total market cap is what people think the sum of all the public companies in the US are worth. Public = tradable (so not mom and pop companies, but ones listed on an exchange).
This is a rough ratio because GDP will include the output of businesses that aren’t listed on any exchange, but it also does not include the total productive output of multinational companies like Apple or Amazon. GDP only measures what happens within the borders of a country. For your own research, compare that to GNP (Gross National Product).
So it’s not totally fair to compare these two numbers, but it’s still pretty dang useful.
Let’s cut to the chase.
The indicator is suggesting the market is valued at 227% its historical trendline. Perhaps the trendline will move up over time, but when you’re two standard deviations outside the mean, it is a flashing red indicator of overvaluation.
There are two ways this deviation resolves: companies become a hell of a lot more productive very quickly without their valuations rising—or valuations fall. Which do you think is more likely?
Reverse Repo
Reverse repo is a nickname for a reverse repurchase agreement.
It’s a tool used by the Fed to manage market liquidity. Liquid = banks have cash to facilitate transactions, particularly in the stock market. If liquidity dries up, the markets can’t function and can result in either huge drops, huge gains, or both. Basically it creates chaos. The Fed doesn’t want chaos. So it uses Repos to add liquidity and reverse repos so banks can earn nominal interest on their cash overnight. Find out more on Investopedia.
Here’s the deal—we just passed a huge milestone on Friday, May 28. We have hit an all-time high of $479.498 billion according to the Fed’s historical data. BILLION, yo. Nearly half a trillion dollars in overnight loans of banks sitting on cash.
Update from July: on June 30, the RRP historical rate was absolutely shattered with $991 billion in overnight loans. This is crazy.
Apparently these loans can happen at the end of quarters or during crises where liquidity is needed to respond to sudden market fluctuations. It’s also a potential sign that yields elsewhere are low (or at least the ratio of yield to risk is too low) so banks would rather leave their cash overnight on the Fed’s balance sheets to earn a farthing of interest. On the chart linked above, you can see the last big spike in March 2020 during market panic at the beginning of COVID.
Without speculating on the reasons why these banks are requiring liquidity relief, this by itself is an indicator of potential instability (or a small market top because there are no worthwhile overnight investments) and lots of cash in the system. It’s not a good enough indicator by itself. There was crazy high reverse repo levels from 2014 to 2018 and we didn’t go into a recession. This metric needs to be viewed in context of other metrics, too.
A sudden spike & all time high with these other danger indicators should catch your attention.
The Big Kahuna: S&P 500 Real Inflation-Adjusted Earnings Yield
This is a mouthful and a half, so I’m just calling it the Big Kahuna. This metric hasn’t failed in decades.
Time for a history lesson. On the chart above, you can see the blue line hit or dip below zero in the early-mid-70s, early 80s, touch the line around ’87, dip the line in 2000, and touch it again 2008.
Do you notice anything about those dates?
The last one should catch your attention. If you’re a bit older, the last two should definitely catch your attention. The others may, too, if you’re a student of market history.
1973 – Oil Crisis in the US
Early 1980s – Multiple Recessions
1987 – Black Monday (sharpest one-day market crash in history)
2001 – Dotcom Bubble
2008 – Housing Crisis
Notice it didn’t even come close to hitting zero at the beginning of the coronavirus pandemic. This is a different event. It tells a very clear story of a fiscal correction coming soon.
I Am Not a Perma-Bear
I don’t root for crashes. Hell, I invested in Tesla in 2020 when any traditional metric said they were grossly overvalued.
But if a market is due for a correction, it’s better to warn people to get out of their positions or buy puts or SOMETHING rather than let everything tumble down sharply with no recourse.
I am positioned in stocks (really just one) with a strong negative beta to the market (AKA I expect it to go up when the market goes down). I’m putting my money where my mouth is.
Everyone knows the market is overvalued. Everyone. What we don’t know is when the correction will take place. Could be another year. I think it could happen much sooner than that (possibly starting on Tuesday, June 1) but I don’t actually know.
If we keep printing money and handing out cheap credit, we will only prolong and strengthen the inevitable. Take shelter while you can.
After the Crash
Once the market eats it, I am pulling out of my position (hopefully at a strong profit) and going heavily into Bitcoin. I still see an apocalypse of inflation on the horizon and Bitcoin as the best hedge against it. This post isn’t about Bitcoin, but rather what I see the Fed trying to do to “save” the economy after the market crash.
I actually think Bitcoin will probably tank along with the market. But it’s not usually wise to try and time crypto, even though it does have a correlation with overall market movement.
My short term plan: find a hedge stock or asset.
My long term plan: dump into Bitcoin. Even if it goes to $10k, I’m dumping in most of my net worth.
This ain’t advice; decide what your own plan is now while you still can.
Edited July 6, 2021: clarifying and restating the section on reverse repos.
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