Sooooo...Where is the Market Right NowWhile I have posted many times that what people do in terms of their investments depends very much on one's investment objectives and tolerance to risk. I have also talked about asset allocation and the need to change/ adjust one's asset allocation over the business cycle. Many empirical studies over the years have identified asset allocation as a key determinant of long term returns in the stock market.
With that as backgound, where is the market right now and is it vulnerable to for a decline in asset values (irrespective of whether there will be a recession next year or not)?
Two indicators I use for shorter term decisions on asset allocation and more specifically the cash component are - market sentiment and the market P/E ratio relative to interests rates.
Right now both of these indicators are flashing red.
Market sentiment is in the Greed category and approaching Excessive Greed. Historically this means that the market is as approaching a shorter term top and the indexes will fall. When this actually happens is not precise as the market could stay in this category for a 2-3 weeks but it is a clear sign to be careful and prepare for a market downturn. When I see this I start to raise my cash levels so I can buy some things on sale later. Do I seel everything?...nope..just a tweak of 5-10% in my cash balances.
In terms of interest rates, there is a longstanding relationship between the overal market P/E ratio and interest rates. Obviously, if interest rates are higher then some market participants will, based on risk tolerances. sell equities and buy fixed income. Right now in the US the S&P 500 P/E ratio is about 27. Long run empirical regression analysis would suggest that the P/E ratio should be around 21. In relative terms this is pretty significant differences and for sure indicated market vulnerbility.
More imprtantly, there is a concordance between the two indicators or in simple terms they are both predicting the same thing.
Up to you whether you take this heart or think it is just nonesense.