Permanently High Plateaus Have Poor Precedents

John P. Hussman, Ph.D.

Based on valuation measures having the strongest correlation with actual subsequent market returns across history, equity valuations have approached present levels in only a handful of instances: 1901 (followed by a -46% market retreat over the following 3-year period), 1906 (followed by a -45% retreat over the following year), 1929 (followed by a -89% collapse over the following 3 years), 1937 (followed by a -48% loss over the following year), 2000 (followed by a -49% market loss over the following 2 years), and 2007 (followed by a -57% market loss over the following 2 years). A few lesser extremes occurred in the 1960’s and 1970’s, followed by market losses in the -35% to -48% range.

Still, history doesn’t unfold at random. One can often anticipate the future harvest by examining the seeds that are sown in the present. Long periods of yield-seeking speculation create an illusion of stability in the present, but produce an inevitable harvest of crisis. Long periods of obscene overvaluation create an illusion of permanently high plateaus, but produce an inevitable harvest of poor long-term returns and wicked losses that complete those market cycles.

Overall, the stock market continues to trace out a broad arc that we view as the top-formation of the third speculative bubble in 16 years.  A marginal new high, if it emerges, would not change that broad assessment. Those who recall the marginal new highs of the S&P 500 in September 2000 (on a total return basis) and October 2007 are well aware that they didn’t represent any sort of “all clear” for the market. Meanwhile, we’re very familiar with the seeds that have been planted by the recent speculative episode, and we believe that the best approach for investors here is to wait for the rain, and be patient for the harvest to follow.

DYI Comments:  Here at DYI we call this broad arc for stock prices "The Great Wait."  With valuation so obscene the return OF your principal is far more important than the return ON your principal.  Here at DYI will leave speculation to others and put money to work when valuations are in our favor.

DYI