Investors are getting nervous. Warren Buffett — arguably the most successful investor of all time — is hoarding cash because he can’t find anything trading at a reasonable price to invest in.
Markets quietly correcting Meanwhile, Mark Minervini — one of the most successful stock traders of modern times – owned up recently to being mostly in cash too. On 2 October he tweeted his observation that America’s Dow Jones Industrial Average (DOW) is catching the headlines by moving higher, while more than half the stocks in the Nasdaq Composite Index are trading below their 200-day moving averages. The significance of that is that there are only 30 stocks in the DOW and around 3,000 in the NASDAQ. Generally, traders consider a stock price trading below its 200-day moving average as a bearish sign.
He also thinks the Russell 2000 index is showing weakness and that’s home to around 2,000 of America’s companies, as the name suggests. His view is that “the broader market is quietly correcting” and he thinks trading conditions are “risky”. Meanwhile, many have been waiting for a significant market correction across the pond for years. If you look at charts for the DOW, Nasdaq and Russell 2000, you’ll see that they’ve all shot up rocket-like for many years without any sign of a meaningful correction. And you don’t have to look very hard to find arguments that many American firms are over-valued. Perhaps the quiet correction could become louder.
Why it matters to us Does it all matter to us here in Blighty? After all, the median forecast price-to-earnings ratio for all shares with estimates in the UK is running at about 13 and the median forecast dividend yield of all UK dividend payers is around 3.5%. Those figures are a long way from the eye-popping valuations we’re seeing with many firms stateside. Well, I think it does matter. The problem for us in Britain is twofold. Firstly, we have a much larger proportion of cyclical businesses in our main indices, such as miners, oil companies, banks and the like, which attract much lower valuations because of their inherent cyclical risk. This means that valuation averages can deliver a false sense of safety. Secondly, there is a long history of our stock market following the big movements in America– especially the deep plunges!
We’ve also got our own problems to worry about. Nobody really knows how the act of actually leaving the European Union and its aftermath will affect the economy, company profits and share prices. That could be a catalyst for a sell-off or maybe even a relief rally once we’ve actually done it and the uncertainty has passed, because stock markets hate uncertainty more than anything else.
Yet if we do see a big correction in the markets, you can bet your bottom dollar that Warren Buffett will start seeing value again, and Mark Minervini will pin down some decent trading set-ups, and both will be filling their boots with stocks. In the meantime, I reckon a good strategy could be to keep dripping money into the stock market whatever happens next and let pound/cost averaging smooth your long-term compounded returns. There’s no need to divert your funds to baked beans and shotguns after all.
Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.