Why I'm Being Cautious With My Portfolio as Indexes Hit Record Highs
Investors are more than content to overlook the myriad risks to the market.
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Equities ran their weekly winning streak up to five last week as the three major indexes all rose just over 1% over five trading sessions.
The Dow and S&P 500 stand at all-time highs while the NASDAQ is just a hair away from its own record high. All of this has happened against the backdrop of the yield on the 10-year treasury moving from just north of 3.6% to 4.1% over the past month. Average mortgage rates have also ticked up notably. Wasn’t the first cut to the fed funds rate since 2020 in mid-September supposed to result in a drop in interest rates?
Meanwhile, the S&P 500 is trading at just over 29-times trailing earnings, according to the latest reading from GuruFocus. The index changes hands at just over 23-times forward earnings for those home gamers. Quite the rarified air from a valuation perspective. Warren Buffett’s favorite valuation metric, equities’ overall market-cap-to-U.S.-GDP ratio, hit another all-time high last week as well.
More concerning to me is the price-to-sales ratio of the S&P 500 is hovering near three. To put this in perspective, it was just over two at the end of the Internet Boom, just before the Internet Bust crushed equity values especially in the NASDAQ, although the S&P 500 fell just over 40%, before stocks finally found a bottom in the summer of 2002. Investors appear to be betting that the AI revolution will be at least comparable to the birth of the internet in regard to what it means for economic and earnings growth.
I am in the rather lonely camp of believing that the economic growth the U.S. has experienced in recent quarters has been goosed significantly by the federal government running a fiscal deficit of just north of 6% of GDP annually over the past two fiscal years. Obviously, with the federal-debt-to-GDP ratio hovering near record highs, this is not sustainable. As it is, the interest on that debt is running north of $1 trillion, with a "t," on an annual basis. At some point, that 800-pound gorilla in the room will need to be addressed.
If the election ends in split governorship between the parties, a good portion of the 2017 tax reduction package, including lower corporate tax rates, is likely to be allowed to expire at the end of 2025. One would think, at some point, the market will have to start to factor that into its valuation equations.
As far as a geopolitical perspective, I share many of the same concerns as Jamie Dimon, who has headed JPMorgan Chase for some 18 years now. Tensions continue to escalate in the Middle East and trade protectionism is on the rise in many countries. While Ukraine has seized some territory around Kursk, its forces continue to fall back at an accelerating pace in the Donbas. The Russians could well seize the strategic hub of Pokrovsk by the end of the year, which would likely mean the loss of the rest of this key battle front.
Therefore, I continue to be quite cautious around my portfolio allocation, seizing the few opportunities that present themselves via covered-call orders and keeping my FOMO urges in check. Myriad growing risks to the economy and markets may continue to be memory holed in the months ahead. However, eventually equities will have to confront reality, and that meeting is likely to be painful when it finally does occur.
At the time of publication, Jensen had no positions in any securities mentioned.
