Cedears: key Wall Street indicator warns of excessive increases in stocks, what to do?

The stocks on wall street are extremely overvalued, according to the indicator Warren Buffettwhich sends a warning to investors and, of course, to those who have Cedears of companies or indexes of the American market. The message is clear, for the investment guru: “you have to be cautious“.

Only on Tuesday, the S&P 500 and the Nasdaq Composite closed at record levels, extending winning streaks driven by strong performance in technology stocks and hopes that the Federal Reserve will cut interest rates soon. Several financial giants also rose, including Goldman Sachs, JPMorgan Chase and Citigroup (C), ahead of the start of bank earnings reporting season later this week.

And the equity market has been supported by optimism that the Fed could be close to starting to cut its interest rate, which is at a 23-year high, with bets that it will happen in September. Although, as he explains to Scope, Emilse Córdoba from Bell Stock Marketthis bullish rally in which the US indices only take a short break to take profits and continue to rise, “clearly cannot be sustained in the long term” and warns that a correction in prices is expected.

This correction, warns Córdoba, will be greater or will be felt with more vehemence.in the assets that have had the greatest increase. Mainly, those that make up the Nasdaq or all those companies linked to artificial intelligence.”

What is the Buffett Indicator and how is it calculated?

As explained to this medium Nahuel GuevaraResearch Analyst at Inviuthe Buffett Indicator compares the US stock market to the size of the economy. For this, “Divide total market capitalization (share prices times the number of shares outstanding) by the U.S. Gross Domestic Product (GDP)“.

Guevara indicates that, at the beginning of July, “The ratio reached levels not seen since early 2022, ahead of the S&P 500’s worst calendar-year decline since 2008“, and this is a clear warning sign. However, he stresses that he does not consider it prudent to determine the current valuation situation of the index solely through this indicator.

“It is true that the S&P 500 is at historically high concentration levels, with the renowned Magnificent 7 (Tesla, Apple, Meta, Amazon, Google, Microsoft and Nvidia -M7-) having driven the index,” he explains.

And this can be clearly seen when comparing the performance of the aforementioned G7 techno, which is +66% in the last year, against only 15% if the Magnificent 7 are excluded from this analysis.. “Notwithstanding the above, the total return was not only based on expectations around generative artificial intelligence (AI), but, during 2023, the M7s also drove the growth of S&P 500 earnings,” says the Inviu strategist, with earnings up 29% compared to a 4.8% contraction in earnings for the rest of the index.

Cedears: the time has come to rotate portfolios

For Córdoba, “currently, there is still a long way to go, but there are already some signs, such as the Buffett indicator, that show signs of exhaustion in the US market.” The strategist is clear in saying that “It is the right time to start closing positions or taking profits. Ideally, making partial sales to average the exit prices”.

Guevara, for his part, suggests that, given the exhaustion of the stock market, a valid strategy is to invest in the S&P 500 Equal-Weight, that is, “with equal weighting in all its shares, to avoid the current strong concentration and benefit from an extension in earnings growth in the rest of the index“as investors pray for a Fed rate-cutting scenario, which, as mentioned, looks favorable.

In line with what Córdoba has proposed, the Inviu strategist believes that, at a sector level and in a tactical horizon of six months, “technologies related to AI can maintain good momentum”, but, at a strategic level and given the need to build new data centers and generate electricity for consumption, “The industrial and utilities sectors may be interesting to benefit from the evolution of AI at lower valuations“.

However, beyond these reasons, as highlighted in the latest IEB Group report, “The US stock market, represented by the S&P 500, has behaved completely differently than most stock markets around the world.“.

Furthermore, within the market of that country, it is evident that there is a differentiated behavior between the S&P 500, Nasdaq-100, Dow Jones and Russell 2000.

For now, the The trend in investment flows continues to be oriented towards leading companies in artificial intelligence and those sectors that benefit most from this technology.but the idea of ​​taking profits or recalibrating portfolios is healthy.