John P. Hussman, Ph.D.
With the S&P 500 Index at the same level it set in early-November 2014, and the broad NYSE Composite Index unchanged since October 2013, the stock market continues to trace out a massive arc that is likely to be recognized, in hindsight, as the top formation of the third financial bubble in 16 years. The chart below shows monthly bars for the S&P 500 since 1995.
Above is NOT John Hussman's chart. If I copy and paste his chart the link goes bad. However this chart though just a bit out of date shows the beginning of a top formation.
It's difficult to imagine that the current situation will end well, but it's quite easy to lose a full-cycle perspective when so much focus is placed on day-to-day fluctuations. The repeated speculative episodes since 2000 have taken historically-reliable valuation measures to extremes seen previously only at the 1929 peak and to a lesser extent, the 1937 peak (which was also followed by a market loss of 50%). Throughout history, at each valuation extreme - certainly in 2000, 2007 and today - investors have openly embraced rich valuations in the belief that they represent some new, modern and acceptable “norm”, failing to recognize the virtually one-to-one correspondence between elevated valuations and depressed subsequent investment outcomes.
[Above chart Shiller PE 10 (average 10 yrs earnings inflation adjusted) returns going forward will be poor (under 2% avg. annualized) at best and negative at its worst DYI.]
Though corporate earnings are necessary to generate deliverable cash to shareholders, comparing prices to earnings is actually quite a poor way to estimate prospective future investment returns. The reason is simple - most of the variation in earnings, particularly at the index level, is uninformative. Stocks are not a claim to next year’s earnings, but to a very long-term stream of cash flows that will be delivered into the hands of investors over time. Corporate earnings are more variable, historically, than stock prices themselves. Though “operating” earnings are less volatile, all earnings measures are pro-cyclical; expanding during economic expansions, and retreating during recessions. As a result, to quote the legendary value investor Benjamin Graham, “The purchasers view the good current earnings as equivalent to ‘earning power’ and assume that prosperity is equivalent to safety.” Not surprisingly, the valuation measures having the strongest correlation with actual subsequent investment returns across history are smoother, and serve as better “sufficient statistics” for the relevant long-term cash flows.
With the S&P 500 still within a few percent of its record 2015 high, investors have a critical opportunity here to understand the difference between a run-of-the-mill outcome and a worst-case scenario. The present ratio of MarketCap/GDP is about 1.2, which we fully expect to be followed by nominal total returns in the S&P 500 of about 2% annually over the coming 12 years. Given the current dividend yield on the S&P 500 actually exceeds 2%, the historically run-of-the-mill expectation from current valuations is that the S&P 500 Index itself will be below current levels 12 years from today, in 2028.
To summarize present market conditions, the most historically-reliable valuation measures remain obscenely elevated; we fully expect nominal total returns for the S&P 500 to average 0-2% over the coming 10-12 years, with negative real returns over both horizons; and we expect a 40-55% market decline to complete the current market cycle. All of these would be only run-of-the-mill outcomes from present valuations. Market internals remain broadly unfavorable, but we’ve recently observed just enough improvement in trend-sensitive measures to hold us to a neutral rather than hard-negative outlook over the very near-term. A break below roughly 1975 would restore a hard-negative outlook. While we have to be comfortable with some amount of near-term uncertainty, I expect the completion of the present market cycle to produce strong opportunities to adopt a constructive or aggressive market stance. As I’ve said before, only informed optimists reject that the market is forever doomed to rich valuations and dismal future returns. That optimistic outlook has a century of evidence on its side.
DYI Comments: Completely agree....Due to world wide central banks they've blown their third bubble since the year 2000. This will end badly especially for those who are 100% invested in stocks. DYI are NOT market timers but market weigher's that simply decease our holdings as valuation rise and increase our commitment as valuations improve. Today valuations are so stretched our weighted formula has "kicked us out" of the market and rightfully so! This market top has been in the making since November 2014 AND turned negative since 2012. I feel that sometimes that I'm the boy who cried wolf. But in the end I know Mr. Market will have his way despite all of the world wide central banks money printing with their sub atomic low rates. Just to prove how absurd they have become in Europe many countries now have negative interest rates. The Fed's are entertaining going negative as well.
Updated Monthly
AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION - 3/1/16
DYI
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