What to Do When Buffett’s Indicator Flashes Red

by Nilus Mattive
By Nilus Mattive

There are plenty of ways to judge what’s happening in the U.S. economy.

But ever since the Covid-19 lockdowns, I’ve been spending a lot of time studying America’s car lots.

In the immediate wake of Covid-19, car sales absolutely fell off the face of the Earth.

Then, as with most things, they quickly rebounded, and prices soared to absurd new heights.

According to data from Kelley Blue Book, the average price of a new car transaction was $48,808 in June, about 27% higher than what we saw back in June of 2020. This chart shows how extreme the move has been …

Click here to see full-sized image.

 

Yet demand remains strong, with new car sales volume up roughly 13% in the first half of this year.

Meanwhile, the average new car payment is now a staggering $716 a month.

Of course, nowhere has the madness been more apparent than in the idea of people paying huge markups over sticker prices to get certain vehicles.

Just to give you a few vignettes from my own life …

Last September, I emailed a big Los Angeles Ford (F) dealer about the upcoming Ford F-150 Lightning.

I knew the new all-electric pickup truck was a hot item, but I was flabbergasted when the dealer offered to sell me the vehicle at $23,000 over the MSRP.

Think that’s crazy?

I’m now about to purchase a special edition of the new Ford Bronco … but not from my local Santa Barbara dealer, where another special Bronco model was recently marked up $50,000 over the sticker price.  

Hey, I understand that certain specialty vehicles always command extra premiums. I also believe in free markets. But this is just plain stupid bubble mentality. And it’s going to come crashing back down on both sides of the equation — on the dealers sacrificing long-term relationships for some quick money, as well as the consumers who end up upside down on their vehicles the minute they drive off the lot.

Indeed, there are some early signs that things are starting to crack ...

The same Los Angeles dealer who offered me the overpriced Lightning just sent me an unsolicited email last week. It noted that Ford has just slashed the model’s MSRP and that it has vehicles on the lot at newly discounted prices.

From $23,000 over sticker to a newly reduced MSRP in less than a year?

Don’t be surprised if we see the same type of about-face across more car lots — and the financial markets — in the months ahead. After all …

Investors Are Still Paying
Big Stock Market Markups, Too

My recent experience with the Ford Lightning pricing highlights the benefit of staying unemotional when you’re looking to buy or sell something.

In fact, it reminds me a lot of the lesson that Warren Buffett’s mentor, Benjamin Graham, taught him about the stock market. As Buffett recounted in his 1987 letter to Berkshire Hathaway shareholders …

“[Graham] said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

“Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times, he feels euphoric and can see only the favorable factors affecting the business. 

“When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times, he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions, he will name a very low price, since he is terrified that you will unload your interest on him.

“Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.

“But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. 

“Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, ‘If you’ve been in the game 30 minutes, and you don’t know who the patsy is, you’re the patsy ...’

“In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. 

“In my own efforts to stay insulated, I have found it highly useful to keep Ben’s Mr. Market concept firmly in mind.”

So, where would we place today’s stock market on the spectrum of prices ranging from “below MSRP” to “way above sticker?”

Buffett himself has a favored way of assessing how much investors are currently paying for stocks — dividing the total value of a country’s stock market by the total value of its gross domestic product. 

In 2001, he told Fortune this is "probably the best single measure of where valuations stand at any given moment." 

He went on to say that a 100% valuation is about right, while a ratio in the 75% range suggests good upside potential ahead. A very richly valued market might trade at a ratio above 120%, which is where the ratio stood in late 1998 and most of 1999 before the tech collapse hit in full force.  

Well, we have now seen the ratio go even higher than it ever did back then … starting around 2014 and continuing through the present ...

Click here to see full-sized image.

 

Should the ratio approach the 200% mark, Buffett has said investors would be “playing with fire.” And as you can see, it finally hit that unprecedented level at the end of 2021.

The market then dropped quite sharply. But it has since climbed its way back to the current level of 170%. And overall, investors have happily kept the market in nosebleed territory for many years now. 

Buffett never promised immediate retribution for a high ratio. After all, as John Keynes is often quoted to have said, “Markets can remain irrational longer than you can remain solvent.”

But there are hedges and protections you can use to brace yourself just in case Buffett’s ratio is, indeed, an indicator of a large sell-off. I’ve shared my favorite hedging method with my Safe Money Report Members. I recommend you check out this presentation and join them, while you can.

Best wishes,

Nilus

About the Contributor

Nilus Mattive is the editor of Weiss Ratings’ flagship Safe Money Report and also its Weekend Windfalls service, which is dedicated to generating up to $1,000 a week through the process of selling options.

 

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