Warren Buffett is regarded as one of the top investors in the world and for good reason. Also known as the Oracle of Omaha, Buffett has consistently managed to beat the index for close to six decades. While he is a financial genius, Buffett often offers some pearls of wisdom to help retail investors create wealth.
All of his investment decisions are closely watched by Wall Street heavyweights and other stock market enthusiasts. As Buffett has the Midas touch, it makes perfect sense to follow his investment strategy that can pay off tremendously for long-term investors.
The Warren Buffett indicator suggests it’s time to be fearful
One of the easiest ways to gauge the market sentiment is by looking at the Warren Buffett indicator that is also known as the gross domestic product (GDP) to stock market ratio. If the ratio is over 100%, it suggests markets are trading at a premium. Alternatively, if the multiple is below 100%, it means the markets are undervalued or trading at a discount.
While GDP figures are expected to plummet in 2020, stock markets continue to trade at record highs. It’s evident that equities are not in sync with the economy, which means a market sell-off is on the cards. In fact, the Warren Buffett indicator for the S&P 500 stands at an astonishing 181%.
While it’s impossible to time the market, you can be prepared for a downturn. For example, Warren Buffett’s Berkshire Hathaway ended Q3 with a cash balance of a staggering $140 billion which will be deployed to buy quality companies trading at a discount.
Berkshire Hathaway, in fact, has spent close to $14 billion in stock repurchases in the last two quarters and sold positions in airline stocks as well as in banking giants such as Goldman Sachs.
What’s next for investors?
It’s possible that Buffett thinks this market rally is unsustainable and he is ready with massive amounts of dry powder. Global economies are in a tailspin and in the midst of a recession. The airline, travel, and tourism industries that accounted for 10% of global GDP continue to experience tepid demand while low interest rates have reduced profit margins of financial institutions.
The retail sector and REITs with exposure to multiple verticals are also under the pump. Crude oil prices might remain volatile as we inch closer to 2021, making oil-producing companies that are trading at depressed valuations unattractive to contrarian investors.
Does this suggest that you need to invest in gold mining companies such as Barrick Gold (TSX:ABX)(NYSE:GOLD)? Gold prices gain momentum when equity markets turn bearish. Further, they also have an inverse relationship with interest rates and the U.S. dollar.
While gold prices have tapered off in the last few months, there are multiple drivers for the yellow metal to surge higher in 2021. This bodes well for mining companies like Barrick Gold with all-in sustaining costs (AISC) of less than $1,000.
Due to surging gold prices, Barrick Gold has been able to increase earnings at a fast pace and is reducing its debt balance to strengthen its balance sheet. Barrick Gold stock is trading 28% below its record high with forward price to earnings multiple of 19.5, which is really cheap considering analysts expect it to increase earnings at an annual rate of 35.6% in the next five years.
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The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short December 2020 $210 calls on Berkshire Hathaway (B shares). Fool contributor Aditya Raghunath has no position in any of the stocks mentioned.