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Priced for Perfection

Robert Kiyosaki

Brian Maher

Contributor, Freedom Financial News
Posted Jan 15, 2025

Dear Reader,

Freedom Financial News contributor Porter Stansberry:

  • Unless you know for certain that you can hold your investments, without fail, for the next decade at least, it’s time to sell… the cheapest of [today’s top tech stocks] is trading at 25 years’ worth of profits. Most of this success has already been “priced in”… I believe we are at a multi-decade, perhaps even century-high, average level of equity prices. 

That is, the stock market’s wagon-pullers are “priced for perfection.”

And perfection… in this fallen and sorrowful vale… is a state of existence rarely attained.

These stock market lovelies will one day — perhaps one day soon — be repriced for imperfection.

The shine will come right out of them.

Scars, pockmarks, age spots and additional blemishes, all will become visible.

Investors will withdraw their favor… and flee from them.

A mighty stampede will ensue. The delirious mob will trample many investors in the proceeding pandemonium.

A Panic That Will Impact All Stocks

Mr. Stansberry continues, with a breaking and trembling voice:

  • Right now, the Magnificent 7 account for 33% of the S&P 500 (that’s an historically unprecedented level of concentration of the biggest stocks)… 
  • Because so much capital is now being invested “automatically” in S&P 500 index funds and because so much of that index is now crowded into so few stocks and because those “Magnificent 7” stocks are very richly valued, a reasonable correction to those stocks’ multiples could easily trigger a panic that impacts all stocks, even those that are reasonably valued.

The fellow refers to valuations. Valuations are often expressed in price-to-earnings ratios (P/E ratios).

A low P/E ratio indicates stocks are cheap. A high P/E ratio indicates stocks are dear.

The lower the valuation… the higher returns investors can expect across the next several years.

The opposite likewise holds true. Elevated valuations imply diminished returns across the next several years.

A P/E ratio of 17 is about par… as history runs.

That is, P/E ratios below 17 indicate stocks are cheap. Above 17 stocks are expensive.

“Mean Reversion”

What are the P/E ratios of these gorgeous “Magnificent 7” stocks, Mr. Stansberry?

  • They trade at an average forward price-to-earnings ratio of 40. And the other 493 stocks in the index? They’re a relative bargain at a P/E of 17. 

Investors in these seven magnificoes are shoveling up $40 for each $1 of earnings.

Again: They are priced for perfection.

If the term “mean reversion” has anything in it — I believe it does — these investors are in for a good, hard whaling.

I simply cannot announce the day or hour.

Shall we now turn to Mr. Warren Buffett and his famous indicator? What would Omaha’s sage say about present valuations?

The Buffett Indicator

The Buffett Indicator is simply the ratio of total United States stock market capitalization to the gross domestic product.

If United States stock market capitalization precisely equals the gross domestic product… you have a reading of 100%.

Wall Street and Main Street are perfectly parallel, the one the perfect mirror of the other.

A reading below 100% indicates a stock market undervalued against the economy underlying it.

Stocks are steals.

A reading above 100% indicates a stock market overvalued against the economy underlying it.

Stocks are dear.

The Buffett Indicator attained a delirious 216% in late 2021 — a record. The stock market soon endured a severe “correction.”

“Significantly Overvalued”

What does the Buffett Indicator presently read?

The answer is 207%. It is but one jot from its precarious 2021 peak.

That is, the stock market is not merely overvalued relative to the gross domestic product.

The stock market is “significantly overvalued” relative to the gross domestic product.

Reports The Globe and Mail:

  • By the end of 2022, the S&P 500 index was down by 20%, and it looks as if we’re headed for another collapse. At recent prices, total market caps are worth more than 205% of the latest reported GDP figure.

Here is your evidence:

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Source: Advisor Perspectives

The More Maniac the Mania… the More Despairing the Despair

I concede it is possible — it is possible — that the Magnificent Seven will rampage clear through 2025 and beyond.

Manias can defy all logic, all sense. And market manias are often the most maniac of all manias.

Yet the more maniac the mania… the more despairing the despair that follows it.

That is because elevated valuations today indicate depressed stock prices tomorrow. The opposite is likewise true.

The stock market will dash inevitably upon the rocks of  mean reversion.

Scales balance ultimately, that which goes up comes down, that which goes down comes up…

The mighty fall, the meek inherit the earth.

I hazard stock market and economy will meet once again on fair ground.

I further hazard they will meet upon the economic level — not the stock market level.

Unsustainable

Mr. Lance Roberts of Real Investment Advice:

  • Stocks can not indefinitely grow faster than the economy over long periods. When stocks deviate from the underlying economy, the eventual resolution is lower stock prices. Over time, there is a close relationship between the economy, earnings, and asset prices…
  • For example, in 2000 and again in 2008, earnings contracted by 54% and 88%, respectively, as economic growth declined…
  • As earnings disappointed, stock prices adjusted by nearly 50% to realign valuations with weaker than expected current earnings and slower future earnings growth.
  • So while the stock market is once again detached from reality, looking at past earnings contractions suggests it won’t be the case for long. 

That is, the stock market will revert to mean — and perhaps soon. In conclusion:

  • The deviation from long-term growth trends is unsustainable. Such was caused by repeated financial interventions by the Federal Reserve. Therefore, unless the Federal Reverse is committed to a never-ending program of zero interest rates and quantitative easing, the eventual reversion of returns to their long-term means is inevitable.

The Cost of Every Pleasure

The Federal Reserve has failed to get inflation back in its bottle. Little credible evidence indicates it will anytime soon.

The Federal Reserve cannot therefore commit to a never-ending program of zero interest rates and quantitative easing.

We must conclude that stock market deviation from long-term growth trends is inevitable.

Yet again I revisit mean reversion.

“The cost of every pleasure” — as the great Buddha likely never said — “is the pain that succeeds it.”

Are investors prepared for the pain that succeeds this pleasure?

Regards,

Brian Maher

for Freedom Financial News