“Warnings From Behind The Curtain” almost sounds like the title of a good “Cold War” fiction novel. However, this time, the story is of warnings for investors not often discussed by the mainstream media.
Notably, there is a necessary clarification that must get made. Warnings have different degrees of outcomes.
For example, a warning label that says “only wash in cold water” has an outcome that results in a shirt that will now only fit a toddler. Conversely, the warning label on a hairdryer explicitly states, “do not use while taking a shower.” The consequence of ignoring such a warning is costly.
The same applies to warnings in the stock market for investors. A “warning” when stocks are not extremely overvalued, excessively bullish, or extended is not as critical as when they are. Therefore, the first thing we need to understand is how important are the warnings we are seeing?
Extended, Excessively Bullish & Over Valued
The advance in the market over the last 12-years is the result of years of monetary accommodation and near-zero interest rates. As such, it is no surprise the deviation of the market from its long-term moving averages is extreme.
The critical thing to remember is that “mean reversions” are a constant throughout history. Therefore, the greater the deviation in one direction, the greater the reversion will be.
Besides getting extremely extended, the market is also excessively overvalued. There are two critical takeaways from the chart below.