John Hussman of the Hussman Funds States: "At normal profit margins, the Shiller P/E would presently be 30" and " our actual estimates of S&P 500 total returns are negative at all horizons shorter than 7 years."

Increasing Concerns and Systemic Instability 

John P. Hussman, Ph.D.

There's really no need to focus on the Shiller P/E, as it doesn't particularly underlie our views. But it's broadly followed so I often discuss it as a useful "shorthand" for other valuation measures. As it happens, the Shiller P/E at 25, versus a pre-bubble norm of just 15, is among the more optimistic valuation measures we track (at least those that have reliable historical records). This is because even the Shiller P/E is moderately biased by variations in profit margins. Its explanatory relationship to subsequent returns can be significantly improved by taking that margin variation into account (See the final chart inDoes the CAPE Still Work?). Think of it this way. The ratio of Shiller earnings (the 10-year average of inflation adjusted earnings) to S&P 500 current revenues is 6.4% here, versus a historical norm of 5.3%. At normal profit margins, the Shiller P/E would presently be 30 – right in line with other more reliable measures at about double its pre-bubble norm. Even at 25, however, the Shiller P/E exceeds every pre-bubble observation since 1871, except for a few weeks leading up to the 1929 peak. 

It’s tempting to look at the 2000 valuation peak as if it’s some sort of goal to be achieved again, rather than a point that has already resulted in 14 years of 3% total returns with the likelihood of another 10 years of similar returns. One hastens to respond (and hastens for reasons below) that the success of the S&P 500 in reaching that pinnacle of valuation was followed by a decline that wiped out the entire total return of the S&P 500, in excess of Treasury bills, all the way back to May 1996, and yet another decline a few years later that wiped out the entire excess return all the way back to June 1995. Taking all of the instances for which data is available, even including the late-1990’s bubble, S&P 500 nominal total returns have averaged less than 1% annually in the 5-year period following Shiller multiples similar to the present. Taking a broader set of historically reliable measures into account, our actual estimates of S&P 500 total returns are negative at all horizons shorter than 7 years.

DYI Comments: John Hussman spells it out correctly that the U.S. stock market is at nose bleed levels.  This places the current market at levels similar to 1929 (except for its final weeks Shiller PE10 peaked at 32.51 Sept. 1, 1929) AND the Great Insanity of the year 2000 peak of 44.20 (Dec. 1, 1999).

As far as DYI is concerned this market is at or higher than THREE SECULAR TOPS; 1907, 1929, and 1966.  This can be easily seen by going to Multpl.com showing their wonderful chart of the Shiller PE10.  The U.S. stock market has been in a secular decline since the year 2000.  DYI's market sentiment chart has the stock market correctly placed just below the ultimate valuation top of the year 2000.  Needless to say it will be a long time before the market bottoms out with the Shiller P10 under 10 and our sentiment indicator at Max-Pessimism.

Market Sentiment

Smart Money buys aggressively!
Capitulation
Despondency--Short Term Bonds
Max-Pessimism *Market Bottoms*MMF
Depression
Hope
Relief *Market returns to Mean* 

Smart Money buys the Dips!
Optimism
Media Attention--Gold
Enthusiasm

Smart Money - Sells the Rallies!
Thrill
Greed
Delusional---Long Term Bonds
Max-Optimism *Market Tops*--REITs
Denial of Problem--U.S. Stocks
Anxiety
Fear
Desperation

Smart Money Buys Aggressively!

Capitulation

DYI