Probably the most important development in financial markets over the last few months is the steep rise in interest rates. Since the Fed started cutting rates with a 50 basis point cut on September 18, the 10 year yield has actually risen about 100 basis points to around 4.70%. Why? The market is clearly signaling its belief that looser monetary policy combined with the policies of the incoming Trump Administration will be inflationary.

This is potentially a problem for stocks that are currently as expensive as they’ve ever been. One measure of broad market valuation is known as The Buffett Indicator. It divides the total market capitalization of US stocks by GDP. It is currently over 200%: “If the ratio approaches 200%, as it did in 1999, you are playing with fire” – Warren Buffett. As almost all of you know, fundamentally the value of a stock is the discounted value of its future cash flows. As the risk free rate rises so does the discount rate and as a result the present value of future cash flows decreases.

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I have offered many examples of extremely overvalued stocks in recent blogs. As another example consider Intuitive Surgical (ISRG). ISRG is the maker of the Da Vinci robots that assist doctors in surgery. I have no doubt that it’s a great product and ISRG is a great company. But it’s P/E multiple on trailing 12 months EPS is 79x at Tuesday’s close ($531.88 / $6.72 = 79x).

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