Welcome to my video presentation for Friday, July 2. My article below fleshes out the themes of the video.

As the July 4 holiday looms on the calendar, stocks this week continue to hover at record highs. Are stocks currently overvalued and on the verge of a correction? In an attempt to make that determination, there are many valuation yardsticks to choose. The well-worn price-to-earnings (P/E) ratio is just one measure.

Key valuation metrics also include the price-to-book ratio (P/B), which indicates what investors are willing to pay for each dollar of a company’s assets; price-to-sales ratio (P/S), which indicates the value placed on each dollar of a company’s sales; and enterprise value-to-EBITDA, calculated by dividing a company’s enterprise value (EV) by its earnings before interest, taxes, depreciation and amortization.

The latter allows investors to compare the value of a company, debt included, to the company’s cash earnings less non-cash expenses.

The Oracle’s favorite valuation tool…

All of the aforementioned valuation gauges point to historically high valuations. But to shed even sharper light on the question, let’s consult a time-proven tool favored by the Oracle of Omaha himself, Warren Buffett.

Buffett by latest estimate is worth $100.4 billion (that figure isn’t a typo), so he must know a thing or two. The tool is called “The Buffett Indicator.”

This indicator, devised by Buffett, is the market cap to gross domestic product (GDP) ratio. It’s a measure of the total value of all publicly traded stocks in a country, divided by that country’s GDP. Buffett described his indicator as “the best single measure of where valuations stand at any given moment.”

The Buffett Indicator is a broad way to assess whether a country’s stock market is overvalued or undervalued. Brace yourself for a possible wave of selling, because the indicator for the U.S. currently hovers at whopping levels. Take a look at the following chart:

The ratio of market capitalizations, as measured here by the broad Wilshire 5000 index to U.S. GDP, is substantially higher now than it was shortly before the dot-com bubble burst in 2000.

Then there’s the cyclically adjusted price-to-earnings ratio (CAPE). Professor Robert Shiller of Yale University invented the CAPE ratio to provide a deeper context for market valuation that takes into account inflation.

The CAPE ratio is defined as price divided by the average of 10 years of earnings (the moving average), adjusted for inflation. Take a look at the following long-term CAPE chart, with data as of market close July 1.

According to the CAPE ratio right now, stocks in the S&P 500 are demonstrating what former Federal Reserve Chair Alan Greenspan once referred to as “irrational exuberance.”

The market appears frothy right now, but you should welcome a temporary pullback. When the investment herd panics, worthy but pricey stocks become affordable again. The market eventually bounces back. It always does.

The upshot: Stay invested but make sure your portfolio contains hedges. Reduce your exposure to growth stocks that have enjoyed a big run-up. Stick to your long-term goals but gravitate toward value.

Watch This Video: How to Hedge Against Mounting Risks

Bullishness should not be synonymous with complacency. As I’ve explained above, the market has reached overbought levels.

I don’t expect a crash this year; underlying conditions are too positive. But we’ll probably see temporary selloffs, triggered by anything from inflationary spikes to pandemic setbacks to geopolitical crisis.

The vulnerable tech sector…

The red-hot NASDAQ currently hovers at a record high. Don’t get me wrong; some technology stocks are great buys now. But many others aren’t. In fact, there’s a slew of much-hyped “story stocks” in the tech sector that trade at nosebleed levels and they’re poised for a tumble.

My colleague Jim Pearce, chief investment strategist of Mayhem Trader, is convinced that we’re witnessing another tech stock bubble. As Jim puts it: “It’s starting to look like 2000 all over again.”

Jim is an expert at making money from market excesses. After pinpointing the most vulnerable stocks in the tech sector, he devised a simple way to profitably leverage their imminent decline. To learn about Jim’s next “mayhem” trade, click here.

John Persinos is the editorial director of Investing Daily. Send questions and comments to: mailbag@investingdaily.com. To subscribe to his video channel, follow this link.