Passive investing, as promoted by the Monday Morning Millionaire Program (15.5% annual return since 2012), does not need or use economic indicators. While proponents of both passive investing and active investing can produce studies to support their position, there is no question about their respective time requirements. 82% of Monday Morning members spend an average of one hour per week or less on their portfolios. By way of contrast, a few years ago, Goldman Sachs reduced (that says “reduced”) interns’ maximum working time to 17 hours per day!
However, many do enjoy active investing. We recommend that they expose a small part of their portfolios to active investing and call it their “fun” portfolios. My “fun” portfolio adds up to 5% of my holdings. It constantly validates passive investing.
Active investors use a large number of economic indicators to predict market movements and we will explore these in the coming weeks.
Today, we will look at Warren Buffett’s favorite, the total stock market capitalization of all U.S. stocks divided by the U.S. gross domestic product. In other words, SMC divided by GDP = market valuation.
It is so frequently quoted in the financial press that we don’t even need to calculate it. We can simply look up the “Buffett Indicator” on a search engine or on YouTube.
This ratio can help us decide whether the market is cheap or expensive compared to historical averages. Buffett called it “probably the best single measure of where valuations stand at any given moment.”
A Buffett Indicator value of 50% is the historical average for the U.S. market. If the value is above 100%, the market is overvalued. The ratio has been inching to higher levels for quite a while now and the accuracy of overvaluation and undervaluation is vigorously debated.
Today (February 20, 2020), it stands at 145.4% which is up from 140.4% the previous quarter. This explains why Buffett is sitting on $190 billion in cash. Active traders should be cautious.
What about Monday Morning Millionaire Program members?
We sleep well.
Next Friday, we will look at interest rates as a leading economic indicator.