The Stock Market Just Flashed a Warning Signal Seen Only a Handful of Times in 150 Years. Here's Where I'd Put Money Right Now.

The Shiller CAPE ratio -- a metric that shows how expensive stocks are relative to a decade of earnings -- recently hit its second-highest level on record (41.5). The last time it was this high was in 1999, when it hit its record high of 44.2, right before the dot-com bubble burst. It also flashed warning signs in 1929 and 2022, foreshadowing bear markets in stocks.

Even though the market is flashing a warning sign, I'm not pulling back. Instead, I'm focusing on building more defensive holdings. Here's where I'm looking to put my money right now.

Image source: Getty Images.

Taking this warning sign seriously

The Shiller CAPE ratio (cyclically adjusted price-to-earnings ratio) measures whether the market is currently cheap or expensive relative to its historical inflation-adjusted earnings record. It has only been above 40 one other time over the last 150 years. The last time that happened, the S&P 500 Index (SNPINDEX:^GSPC) lost nearly half its value over the next two and a half years. It also more recently hit a notable high of 38.6 in October 2021. That preceded a 25% crash in the S&P 500 the following year.

Given this historical precedent, I'm starting to build out more defensive positions in my portfolio. I'm beginning with Berkshire Hathaway (NYSE:BRKA)(NYSE:BRKB), Procter & Gamble (NYSE:PG), and Realty Income (NYSE:O).

Built to capitalize on a crash

I currently have a relatively small position in Berkshire Hathaway. I plan to meaningfully add to it in the coming months as I sell lower-conviction positions. I think Berkshire is the quintessential defensive holding, with significant offensive upside in a subsequent recovery.

At its core, Berkshire is a collection of cash-generating, more defensive businesses. Its operating businesses include insurance, rail, utilities, energy, and other manufacturing, service, and retail businesses. These businesses generate earnings that Berkshire reinvests in acquiring additional operating businesses and public equities. Its public equity portfolio features several high-quality, defensive businesses, including consumer staples giant Coca-Cola (9.8% of its investment portfolio). Berkshire also has over $365 billion in cash (about one-third of its market cap). If there's a market downturn, Berkshire can use that cash to invest in more public equities at lower prices, repurchase its shares (likely at a lower valuation), and potentially take additional high-quality companies private at attractive valuations.

As durable as they come

I don't currently own shares of Procter & Gamble. However, the consumer staples giant is a classic defensive holding. It owns one of the world's highest-quality portfolios of consumer household brands, including Dawn, Gillette, Pampers, and Tide. Demand for its products is very resilient and steadily rising.

We see evidence of this durability in Procter & Gamble's dividend. The company has paid a dividend for 136 years since its incorporation in 1890. It has increased its dividend for 70 straight years, one of the longest streaks among the elite Dividend Kings, a company with 50 or more years of annual dividend increases. With a nearly 3% yield, Procter & Gamble offers a solid income stream and a real return during a downturn. Procter & Gamble's durability and dividend put it high on my defensive stock buy list.

Proven outperformance during downturns

Realty Income has a strong record of performance during stock market sell-offs. Since its public market listing in 1994, the REIT has outperformed the S&P 500 during 11 of its 13 corrections (10%+ declines).

The REIT has several defensive qualities. It owns a diversified portfolio of retail, industrial, gaming, data center, and other properties secured by long-term net leases with many of the world's leading companies. Most of its rent comes from tenants in non-discretionary, service-oriented businesses resilient across economic cycles. Realty Income also has a strong financial profile. The company's stable, growing rental income supports its steadily rising monthly dividend (nearly 6% yield). It has increased its payment 136 times since 1994.

I already have a solid position in Realty Income. However, given its strong defensive qualities, I plan to make it an even larger foundational holding to help anchor my portfolio.

Building more relative resilience, not immunity

A high CAPE ratio doesn't necessarily mean we're heading toward a market correction. However, I'm taking this warning sign seriously by adding more defensive holdings to my portfolio, especially as I get closer to retirement. I think these stocks will hold up better during a market downturn, though I don't expect them to make my portfolio immune to a sell-off. I'm seeking greater stability as we head into what could be a more volatile period, which these companies can provide.

Matt DiLallo has positions in Berkshire Hathaway, Coca-Cola, and Realty Income. The Motley Fool has positions in and recommends Berkshire Hathaway and Realty Income. The Motley Fool has a disclosure policy.