October 17, 2016
John P. Hussman, Ph.D.
Several weeks ago, we shifted from a rather neutral near-term stock market view, to a hard-negative outlook, based on fresh deterioration in various trend-following components within our broad measures of market action.
From a cyclical perspective, the stock market has effectively gone nowhere since mid-2014 (with zero total return on the broad NYSE Composite since then).
The past two years can be characterized less as an ongoing bull market than as the extended top-formation of the third speculative episode since 2000, the third most extreme equity market bubble in history (next to 1929 and 2000),and
the most extreme point of overvaluation in history across the broad cross-section of individual stocks and asset classes.
We don’t expect the current situation to end well for investors who insist on taking larger investment exposures than they’re actually willing to hold, with discipline, through a period of severe market losses.
From present valuation extremes, a 40-55% market loss would represent a fairly run-of-the-mill resolution to the current market cycle;
a decline that would take valuations only to the high-end of the range they’ve visited or breached over the completion of every market cycle in history. By the completion of the current cycle, I expect over $10 trillion of what investors count as paper “wealth” in U.S. equities to disappear without a trace.
So contrary to the idea that Fed-induced yield-seeking speculation has created “wealth,” the fact is that monetary policy has done little but to distort the financial markets and encourage repeated cycles of malinvestment and collapse. It’s misguided to imagine that the gap between the future consumption needs of an aging population and the future output of a productivity-challenged economy can be addressed by central banks through greater purchases of riskier assets or “helicopter drops" of spending power, as if speculation generates economic productivity or fiscal policy is run by central banks rather than Congress. No. The only way to close the gap is through policies that encourage productive real investment at every level of the economy, rather than fostering pointless financial speculation. Every day that central banks hold out the false hope of a paper solution is a day that chips away at the productive foundations of our economy.
DYI Comments: Professor Hussman you are "SPOT ON" - "A DIRECT HIT!" DYI's weighted averaging formula in 2012 pushed us out of stocks entirely and rightfully so! Valuations based on my favorite - dividend yield are now 109%(rounded) above it's mean. Stocks will need to drop approximately 54% only to be back at their mean yield of 4.39%. This will NOT create a once in a lifetime buying opportunity! Stocks will only have regressed back to their mean. Of course who knows how much of a drop? DYI's estimate is 45% to 60% decline. Admittedly this is my best guess based on valuations and history. What we do know valuations are so absurd returns over the next 10 years, at best, will be 2% nominal. That is before fee's, commissions, and of course INFLATION. The Fed's are hell bent on 2% inflation as a norm. Once they finally achieve their objective the inflation cat will be out of the bag requiring them to slam on the brakes.
My model portfolio remains as defensive as ever.
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