Exit Strategy 
John P. Hussman, Ph.D.

The S&P 500 set a marginal new high on Friday, in the context of a broad rollover in momentum thus far this year that we view as likely – though of course not certain – to represent a broad cyclical peak of the sort that we observed in 2000 and 2007, as distinct from spike-peaks like 1987. Valuation measures remain extreme, with the market capitalization of nonfinancial stocks pushing 130% of GDP (relative to a pre-bubble norm of about 55%), the S&P 500 price/revenue ratio at 1.7, versus a pre-bubble norm of 0.8, and the Shiller P/E near 26 – which while lower than the 2000 extreme, exceeds every pre-bubble observation except for a few months approaching the 1929 peak. We presently estimate 10-year nominal total returns for the S&P 500 Index averaging just 2.3% annually, with zero or negative total returns on every horizon shorter than about 7 years. 

Low volatility and suppressed short-term interest rates are a breeding ground for yield-seeking speculation. This reach for yield has now driven junk bond yields to about 5%, which is interesting given that yields are now near or below typical historical default rates. Meanwhile, the majority of new debt issuance today is taking the form of leveraged loans to already highly-indebted borrowers, with “covenant lite” features that provide little recourse in the event of default. This is the sort of behavior that should wake investors up like a triple Espresso. It doesn’t because they have been conditioned to focus on yield alone, without considering the minimal amount of capital loss that would wipe that yield out. This is not a new dynamic, and precisely because it is not a new dynamic, one can always find solace from the same Broadway kick-line of dancing clowns that reassured investors that credit was sound, subprime was contained, and stocks were still cheap in 2000 and 2007.

Keep in mind also that stocks were priced for long-term returns in the mid-teens for decades prior to the mid-1950’s despite short-term interest rates that were close to zero. Absent a clear inflationary dynamic, the relationship between Treasury yields and prospective equity market returns is much weaker in the historical data than investors seem to believe. In my view, the fact that defensive investors are earning “next to nothing” in Treasury bills is not an objection that should make investors opt instead to risk a 40-60% portfolio loss. I know – that range sounds too extreme. For a reminder of how all of this works, see my April 2007 piece, Fair Value: 40% Off. 

This is a huge sign the markets aren't healthy

The market is making new highs on the backs of fewer and fewer stocks. The one-month daily average of stocks hitting 52-week highs is currently about 26. One year ago, that number was about 101. In other words, we've gone from 1 out 5 stocks in the S&P 500 hitting highs to just 1 out of every 19.

World shares hover near all-time high

LONDON (Reuters) - World shares hovered just off an all-time high and the euro was steady on Tuesday, as the European Central Bank made sure there was little doubt in investors minds that global liquidity will continue. 

Britain's FTSE 100 opened up 0.3 percent as it played catch-up after a holiday. The rest of Europe's main bourses, which saw mostly steady starts, had made gains on Monday following European election results. 

Asset markets around the world continue to be supported by record-low interest rates in most of the world's big economies.

DYI Comments:  A world wide stock and junk bond market bust is on it way soon.  The wait may seem long in real time but after it is over it will seem like a blink of eye for the long term value players.  

J. Paul Getty said it best:

  "For as long as I can remember, veteran businessmen and investors - I among them - have been warning about the dangers of irrational stock speculation and hammering away at the theme that stock certificates are deeds of ownership and not betting slips. 

The professional investor has no choice but to sit by quietly while the mob has its day, until enthusiasm or panic of the speculators and non-professionals has been spent. He is not impatient, nor is he even in a very great hurry, for he is an investor, not a gambler or a speculator. There are no safeguards that can protect the emotional investor from himself."

DYI