Nils Bohlin used to design ejector seats for airplanes.But in the 1950s, he started working for Volvo and was tasked with inventing a safer seatbelt for cars.At the time, cars only had lap belts, but Bohlin wanted to create something that would be more effective at keeping people safe in car crashes.So, he came up with the three-point seatbelt, which is the kind of seatbelt we still use today.You’re likely aware, the three-point seatbelt goes across your lap and over your shoulder, which helps distribute the force of a crash across your body instead of just your waist.This can greatly reduce the risk of injury or even death in a car accident. Prevention is important.Before Bohlin’s invention, many people didn’t like using seatbelts because they were uncomfortable and restricted their movement.But the three-point seatbelt was much more comfortable and easier to use, so it quickly became popular – and safe.According to the National Highway Traffic Safety Administration, seatbelts save about 15,000 lives every year in the United States alone.
- What can the invention of the seatbelt – which prevents the loss of about 15,000 lives each year in the USA alone – tell us about making preparations in the stock market?
Glad you asked.While markets continue to climb a wall of worry, let’s look at some of the warning signals in the market…
Warning #1 – The Buffett Indicator
The Buffett Indicator is a tool used by investors to figure out if the stock market is overpriced or underpriced.Basically, the Buffett Indicator looks at the total value of all publicly traded companies in a country and compares it to the size of that country’s economy.
- If the ratio of the two is high, it suggests that the market might be overvalued and due for a correction.
- If the ratio is low, it suggests that the market might be undervalued and there could be opportunities for investors to buy stocks at a good price.
Over time, the stock market has grown apart from the real economy, thanks to an era of cheap money. This made it easier for companies to leverage up and grow faster than the economy itself.In turn, market players have been pricing in more share price appreciation relative to fundamental corporate cash flow growth rates. But with big changes in interest rates, these high hopes seem less likely.Why? Because growth funded through ultra-cheap debt is not an option anymore.There’s not an endless supply of free money. Higher interest rates suppress growth rates.Based on this macro indicator, we are solidly in overbought territory.
Warning #2 – The Yield Curve
The 10-year, 2-year yield curve is a comparison that gets a lot of press.It’s a way of measuring how much money you can make if you invest in the US government’s bonds for different lengths of time.This means people are comparing how much money you can make if you invest in a 10-year government bond versus a 2-month government bond.Usually, when you invest in something for a longer time, like a 10-year bond, you would expect to make more money. That’s because you’re taking on more risk by locking your money away for a longer time.But sometimes the opposite happens, and the shorter-term bond actually makes you more money.So, what’s the yield curve telling us right now?An inverted yield curve, where the shorter-term bond pays more than the longer-term bond, is often seen as a warning sign that the economy might not be doing so great in the future.It leads to an interesting psychological dilemma for an investor.
- Do I put cash to work today, knowing that the market is pricing in worse conditions down the road?
You may have heard of the term “yield curve inversion” before.This is the scenario when short-term bonds have higher yields than long-term bonds.Plotted in black against the 2 year-10 year spread is the Wilshire 5000. It is a large and diverse market capitalization weighted index of 3000+ US equities.
You can see there is an interesting pattern that occurs.
- When the yield curve goes negative, the market typically declines substantially shortly after.
The early 90s market decline, the dot-com crash, and the financial crisis were all preceded by this yield curve inversion. Here we are highlighted in yellow, with the largest negative spread since the 1980s.I believe there is strong potential for this spread to widen further. This past week US Federal Reserve Chair Jerome Powell testified in Washington and stated that it was likely there could be an additional 2 rate hikes this year.Based on the economic climate later this year, this could send the yield curve to its steepest inversion ever.
Warning #3 – Stock Markets and Interest Rates
The stock market and interest rates move in opposite ways for two reasons.First, when the interest rates go up, companies have to pay more to borrow money for projects.This makes it harder for them to make money and some projects might not even happen at all. When profits go down, the stock prices go down too.On the other hand, when the interest rates go down, companies can borrow more money and make more profits.Second, when the interest rates go up, people can make more money by investing in debt things like bonds on term deposits.So, they don’t want to invest in stocks anymore.
- This makes the demand for stocks go down, and their prices go down too.
But when the interest rates are very low, people don’t have many choices, so they invest in riskier things like stocks to make more money.This makes the prices of stocks go up…Certain companies are highly sensitive to interest rate changes.More significant moves upward can be bearish to companies because the cost of capital goes up.Years in the Making…Taking all this into account, there is one particular company that’s rocketed up to the top of my watchlist as one I’m just about to buy after YEARS of waiting patiently like an alligator.I just revealed it to my subscribers earlier this month and you can get the full write-up in my premium research letter, Katusa’s Resource Opportunities.Regards,Marin Katusa
Details and Disclosures
Investing can have large potential rewards, but it can also have large potential risks. You must be aware of the risks and be willing to accept them in order to invest in financial instruments, including stocks, options, and futures. Katusa Research makes every best effort in adhering to publishing exemptions and securities laws. By reading this, you agree to all of the following: You understand this to be an expression of opinions and NOT professional advice. You are solely responsible for the use of any content and hold Katusa Research, and all partners, members, and affiliates harmless in any event or claim. If you purchase anything through a link in this email, you should assume that we have an affiliate relationship with the company providing the product or service that you purchase, and that we will be paid in some way. We recommend that you do your own independent research before purchasing anything.
