Are the stars aligning?

Imagine this: It was late September 2021, and an air of concern loomed over the equity markets. Why? Well, let me take you back to that moment when the world seemed to hold its breath, anticipating a significant shift.

Valuations were the talk of the town, particularly regarding the elusive free cash flow yield (FCFY). I vividly recall questioning my friends, scratching my head, and wondering, "Why would a meager FCFY of 2-2.5% be considered fair? We used to set the bar at a solid 4-4.5%!" The numbers just didn't add up, and the more I pondered, the more apprehensive I became.

As time passed, a series of indicators began to align, like stars in a celestial dance, warning us of potential risks lurking in the shadows of the equity markets. Now, let's fast forward to the present and prepare for a comprehensive list of these signals, which paint a rather worrisome picture:

Firstly, we have the enigmatic Skew Index, my trusty companion in market analysis. If you've been following my weekly reports, you're familiar with this index—the equivalent of my personal crystal ball. Currently, it hovers around 150, inching closer to its all-time high of 170 recorded back in June 2021. Interestingly, history tends to repeat itself, and whenever this index reached such heights, significant market corrections followed within a couple of months. Quite unnerving, isn't it?

Next, let's discuss the VIX Index, also known as Wall Street's fear gauge. Picture this: a sudden surge of approximately 30% last week, propelling the index above 17. In normal and stable times, this index typically stays around 10, enjoying a peaceful existence like sipping margaritas on a sunny beach. But not this time. It's as if the VIX is desperately trying to communicate something, shouting from the rooftops, "Get ready for a bumpy ride, folks!"

Market valuations, the stuff that dreams and nightmares are made of, warrant our attention. The S&P 500's price-to-earnings ratio currently resides in the big leagues, lingering at around 25 times. Yes, you heard that right. These elevated levels even make seasoned investors raise their eyebrows in concern. It's almost as if the market is signaling, "Hold on tight; we're in for an exhilarating rollercoaster!"

Now, let's shift our focus to the venerable Berkshire Hathaway, led by none other than the legendary Warren Buffett. This company knows a thing or two about playing the market game. And guess what? Even they seem a bit hesitant to dive headfirst into the fray. Their cash reserves, a staggering $147.38 billion as of June's end, sit comfortably near a record high. It's almost like they're suggesting, "Hey, folks, maybe it's time to exercise caution."

But what about good old consumer spending, you ask? Well, let me tell you, while the economy currently thrives on consumer habits, a peculiar trend is emerging. Excess savings, which skyrocketed during the pandemic, are now plummeting, particularly in the US market. It's as if the party is winding down, and we're left wondering how long the music will keep playing.

Now, let's take a trip to the land of the Great Wall. China's long-awaited economic recovery seems to be playing a game of hide-and-seek. Disappointing trade data reveals a significant decline in July exports, the worst since February 2020. To make matters worse, imports have fallen even further than economists predicted. It's as if China's economy is desperately searching for stability, caught in a game of tag.

Oh, and did I mention the changing investment landscape? Brace yourself for this revelation. The era of There Is No Alternative (TINA) is gradually fading away. Bonds, my friend, are stepping into the spotlight, offering attractive yields both in the USD and Europe. Equities have had their time in the sun, with the S&P 500 boasting an astonishing 16% rise. This is enough to make investors reconsider their strategies and contemplate adjusting their asset allocations. Are we witnessing a grand reunion between equities and bonds, dancing to the rhythm of negative correlation?

But hey, it's not all despair and desolation. According to FactSet, approximately four-fifths of S&P 500 companies reporting their quarterly results have exceeded Wall Street's expectations. Yes, you heard that right. Some companies are aligning with the stars, even if the overall picture appears somewhat uncertain.

And just when you thought I couldn't inject any more excitement, let me introduce you to my dear friend, equity risk premia. It's a ratio I closely monitor, and guess what? It's currently flaunting levels last seen in 2021. It's as if the market is engaged in a high-stakesgame, tantalizing us with the potential for rewards or the threat of losses.

Now, before you rush to call your financial advisor in a panic, let me make one thing clear: I'm not here to offer financial advice. No, no, my friend. It's essential to consult with experts who can navigate the intricate maze of asset allocation. However, I couldn't resist sharing this thrilling exercise and giving you a heads-up.

The stars are aligning, my friend. The signs are growing stronger, building up like a crescendo in a symphony of uncertainty. In this economic environment where stock selection takes center stage, it's crucial to choose your investments wisely. Gone are the days when "index investing" reigned supreme. It's time to dust off your magnifying glass, don your detective hat, and search for those hidden gems.

So, grab your popcorn, settle into your favorite armchair, and observe as the drama unfolds. The markets are a stage, and we all play a part in this grand performance. Will the signals prove accurate? Only time will reveal the truth. But one thing is certain: it's going to be one wild ride!