May 2025 | Keaney Financial Services Corp. Commentary
Authored by our investment advisory team
A client asked, "If the markets are down, isn't it a time to buy?" Although it is a reasonable question, a lower price isn't the same as undervaluation. Without considering a stock or index's forward earnings, fundamentals, or current macroeconomic risks, many investors may be confused into thinking a pullback is a bargain.
I realized many people are still confused by headlines and noise and may think it's time to "buy the dip." Historically, this mantra has been a favorite among investors in bull markets. In many cases, however, it is without merit, as people think about price and noise ("MEDIA") and not the fundamentals or proper valuation of the underlying asset they want to purchase.
This mentality has been created by recency bias, which has been developed by the heavily stimulated and distorted markets of the last twenty-four years. "Recency Bias" is when people tend to place greater importance to recent information when making investment or other decisions. This often comes at the expense of historical patterns and long-term data. The dangers of this thinking can lead to poor decision-making, such as:
Chasing Performance (Buying High/Selling Low)
Overreacting to short-term news (News & social media, we call it noise.)
Ignoring long-term strategies or fundamentals
There have been many cases where the markets have corrected 10-15% and were still considered expensive. In many of these instances, it was the beginning of a much larger trough. In my career, I've noticed people are very cautious about overpaying for things like homes, cars, computers, and other miscellaneous items. Still, people will invest in a very irrational fashion. For example, people invest:
Following Hype or Social Media Trends, Platforms like Reddit, TikTok, and X (formerly Twitter) have fueled meme stock frenzies, often leading investors to invest without understanding the company, its financials, or its risks." Everyone is buying it, it must be a winner!"
Investing based on price, while ignoring the reason behind a recent decline, that price drop could reflect deteriorating fundamentals, long-term business issues, changes in the macroeconomic environment, or changes to fiscal and or monetary policy. Over the last twenty-four years, the markets and the economy have been driven by massive amounts of stimulus from policymakers, including quantitative easing and low interest rates. "Stocks are on sale! The markets are down. Buy the dip!"
Chasing recent performance is a classic case of recency bias, and FOMO (Fear of Missing Out) can lead to buying after a run-up in the markets, buying near or at a peak, and panic-selling on pullbacks. "I don't want to miss out. It's up 30% this month!"
Retail investors often misunderstand new headlines or earnings reports, misreading earnings beats or headlines without context (or not reading them at all). Sometimes, a beat may hide deeper issues like declining guidance or margin compression. Understanding the quality of earnings is essential, as many fail to differentiate between headline numbers.
Investors often believe that "the markets always come back" without considering their time horizon, which is a common mistake. At Keaney Financial Services Corp., we believe active, adaptive, and strong risk management is necessary. In the history of our two-century-old stock market, the markets have tended to recover over time. Still, recovery has often taken years or decades, depending on the starting valuations, economic cycles, structural changes, or market or domestic economic distortions created by the FED or some government stimulus.
Investors at or near retirement may not have the luxury of waiting 5 to 15 years for a complete rebound, especially with the stress or need for income and liquidity.
As asset managers who strongly focus on risk management, we need indicators and metrics to measure market and economic data. Two ratios we use to gauge whether the broader stock market is undervalued, fairly valued, or overvalued are the Shiller P/E and the Market Cap to GDP Ratio.
In the chart below, you will see the Shiller P/E Ratio (CAPE – Cyclically Adjusted Price-to-Earnings)1 is one of the many tools we use as a valuation metric that utilizes the average inflation-adjusted earnings of the S&P 500 over the past 10 years. We use this metric to smooth out the distortions, as traditional P/E ratios are less stable in volatile markets. It's helpful in forecasting long-term returns. The higher Shiller P/E ratio levels have historically been correlated with forecasting lower 10 to 15-year forward returns. Although, according to our research, the last 24 years have been an anomaly as fiscal and monetary policies have truly distorted these readings as low interest rates, M-2 money supply expansions, and quantitative easing have allowed market expansion even after reaching ratios above the norm. As of today, 05/13/2025, you can see that the Ratio is at the third-highest level since the 1900s. The grey areas show you U.S. recessions. As you can see, this metric tells us the markets areOVERVALUED, with higher-than-normal risk and below-average expected returns.2 We use this to see if we invest in a bargain or a bubble.
No metric is perfect, as the Shiller P/E Ratio is not ideal in understanding short-term volatility and can easily overstate valuations during recessions or times of rapid changes in earnings. This is one of the thirty-plus tools we use to evaluate markets and have a deep understanding of the macroeconomic environment.
Another ratio we use is the Market Cap-to-GDP ratio, or Buffett Ratio, which Warren Buffett popularized. This broad valuation metric compares the total market capitalization of the country's stock market to its Gross Domestic Product (GDP). To calculate: Buffett Ratio = (Total U.S. Market Cap / U.S. GDP) ×100
The current calculation has the Ratio at 196.4%, which puts the metric at the high end and states the markets are SIGNIFICANTLY OVERVALUED, with higher-than-normal risk and below-average expected returns.3
How to interpret Market Cap-to-GDP ratio4:
We use this as a general guideline for a macro-level valuation to see if the overall market is priced rationally relative to the country's economic output. Historically, high ratios preceded market corrections or long periods of low returns; this tool helps with long-term forecasting, as a high ratio has historically correlated with below-average future returns over seven- to ten-year periods.
Take a look at the 20-year average Ratio above. You can see the 20Y AVG Modified Ratio is 100.68, while the Ratio is currently near the all-time peak set last year of about 206%. According to GuruFocus, the Ratio tells them the stock market is likely to return 0.60% over the next 8 years5. Regardless of how it really pans out, knowing these ratios helps identify risk and allows us to adjust our risk-managed portfolios.
Like every Ratio, it has limitations as it doesn't adjust for interest rates or global corporate earnings from companies that earn revenue abroad. Other weaknesses of the Ratio include tech-dominated economies and short-term investing.
To give you context historically, please review the recent recessions and peaks:
As the markets and world change from unilateral to multilateral, we enter a new era marked by elevated valuations, distortions from fiscal and monetary policies, including structural and trade uncertainty, all while gold is reintroduced into the global financial system, somewhat quietly. Using traditional investment instincts like "Buying the dip" can lead to costly missteps if not grounded in fundamentals, valuation discipline, and economic context. Of the many tools we use, the Buffett Indicator and Shiller P/E offer long-term insight into market conditions, helping us help our clients avoid emotionally driven decisions and unrealistic expectations. As fiscal imbalances rise and monetary tailwinds fade, at Keaney Financial Services Corp., assessing opportunities through a disciplined, data-informed lens is more important than relying on outdated habits or short-term narratives.
References:
www.gurufocus.com -Shiller P/E Ratio (CAPE – Cyclically Adjusted Price-to-Earnings)
www.ycharts.com- Chart - Shiller P/E Ratio (CAPE – Cyclically Adjusted Price-to-Earnings)
www.gurufocus.com- Buffett Indicator: Where Are We with Market Valuations?
www.gurufocus.com - Buffett Indicator: Where Are We with Market Valuations?
www.gurufocus.com - Buffett Indicator: Where Are We with Market Valuations?
www.gurufocus.com - Buffett Indicator: Where Are We with Market Valuations?
Disclosure & Disclaimer
The content provided in this commentary reflects the opinions of Keaney Financial Services Corp. as of the publication date. It is intended solely for educational and informational purposes. It should not be construed as individualized investment advice, a solicitation to buy or sell any security, or a recommendation for any particular investment strategy. All views are subject to change without notice based on evolving market, economic, or political conditions. While we strive to ensure accuracy, the information presented is based on sources believed to be reliable, but we make no guarantee as to its completeness or accuracy.
The opinions shared herein are those of our advisors and are not intended to represent the position of any regulatory agency, organization, committee, group, individual, or third-party institution. Consult your qualified financial, legal, or tax advisor before making investment decisions.
Risk is an inherent aspect of all investment activities, and investors must recognize that no investment is entirely free from risk. Although important, asset allocation, risk management, and diversification strategies do not guarantee generating profits or shielding against losses.