Americans tend to divide their money between two giant types of investments: the stock market and real estate. And by one analysis, the interplay between those two can offer significant market guidance.
Specifically: When stocks get out of whack, sucking up more than their usual share of investment dollars, a market crash can’t be too far off. That’s the thesis of the so-called Sound Advice Risk Indicator, an index comparing stocks to home prices, overseen by Gray Emerson Cardiff, editor of the Sound Advice newsletter.
Cardiff, who began compiling the index in the 1980s and has calculated its levels back to late 1800s, says it recently reached a level hit only five times in the past 120 years — and that each time, that peak was followed by a major market decline.
The index, calculated by comparing the level of the S&P 500 to the national median price for new houses, recently rose above 2. The reading, which suggests stock prices have grown especially lofty relative to home prices, was last reached in 1998, shortly before the dot-com crash.
Other years the index hit a level of 2 were in 1906, 1928, 1937, and 1965— all of which were followed by big stock market declines.
Cardiff, who uses the benchmark as one the two main factors in his investment model, says index spikes don’t always give way immediately to a bear market or recession.
“Stock prices often stayed high for many months, sometimes even a couple of years,” he wrote recently. “However, in all cases, a major decline or crash followed, pulling down stock prices by 50 percent or more.”
Cardiff’s indicator is hardly the only one to suggest stocks may be overpriced. A slew of economic readings, from housing starts to the yield curve, have been suggesting a bear market may be overdue. So far, stocks have shrugged them all off, continuing what’s arguably the longest bull market in history.
Still, Cardiff warns, it would be foolish to assume stocks can continue to rise at the pace they have over the past several years.
“It’s a good time to have some cash on the sidelines,” he says.