Blodget: Stocks still 30 - 40% overvalued
The chart shows what most students of market history quickly learn: Stocks move in distinct "bull" and "bear" phases that often last for decades:
The big argument among market pundits these days is whether the market is still in the middle of the "bear" phase that began in 2000 (14 years and counting) ... or in the middle of a new "bull" phase that started at the financial-crisis low in 2009 (five years and counting).
The bulls look at the chart above and point out that we moved sideways for 10 years after 2000, say that was plenty, and predict that stocks will now obviously forge ever higher for years as the new bull market continues:
Bears, meanwhile, look at the chart and see a temporary, Fed-fueled spike in the middle of a long bear market that they believe will see at least one more big downtrend and correction (likely lasting years) before it is done:
Throughout history, stock prices have loosely gravitated around the "fundamentals" of the underlying companies — namely, earnings. Specifically, stocks have traded in a range of 5X cyclically adjusted earnings (at bear-market lows) to 44X earnings (at the peak of the biggest bull market in history — the one that ended in 2000). The "average" P/E ratio over this period, meanwhile, has been about 15X.When you add P/E ratios to the charts above, you quickly notice a pattern:Sustained bear-market periods have begun when the P/E is very high (~25X+).Sustained bull-market periods, meanwhile, have begun when the P/E is very low (5X to 9X).In other words, sustained bull markets begin when investors are so disgusted by stocks — and so pessimistic about the future of stocks — that they'll pay only 5X to 9X earnings for them. And sustained bear markets begin when investors are so giddy with excitement about stocks and the prospects for stocks that they'll happily pay 25X earnings or more for them.But we can make a couple of observations:
- First, the P/E ratio at the recent peak was higher than the P/E ratio at any time in the past 115 years, with the brief (and very temporary) exceptions of the two great market peaks of 1929 and 2000. For the "new bull market" to continue indefinitely, therefore, the market's P/E would have to continue to keep rising toward the P/E at the historic 2000 market peak — which, it is worth noting, was followed by a devastating crash.
Unless something has changed that makes the past 115 years of market history irrelevant (always possible, but probably not likely), it would not be surprising if the biggest bull-market peak in market history was followed by one of the biggest bear-market workouts in history — one that, perhaps, might last as long or longer than any major workout period to date.
- Second, if we are indeed in the middle of a new bull market, the bear-market "workout period" following the 2000 peak lasted only nine years. That's considerably shorter than the three other big workout periods in the 20th Century: The 19-year workout from 1901 to 1920, the 19-year workout from 1929 to 1948, and the 18-year workout from 1966 to 1982.
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John P. Hussman, Ph.D.
Our most important lessons in the half-cycle since 2009 are not that overvaluation and overextended syndromes can be safely ignored. Historically, we know that these conditions are associated with disappointing subsequent market returns, on average, across history. Rather, the most important lessons center on the criteria that distinguish when these concerns may be temporarily ignored by investors from points when they matter with a vengeance. In other words, our lessons center on criteria that partition a bucket of historical conditions that are negative on average into two parts: one subset that is fairly inoffensive, and another subset that is downright brutal. Central to those criteria are factors such as deterioration in the uniformity of market internals, widening credit spreads, and other measures of growing risk aversion. Once that shift occurs, market declines often bear little proportion to whatever news item investors might latch onto in order to explain the losses.
In short, recent weeks have seen a strenuously overbought record high in the S&P 500 featuring the most lopsided bullish sentiment (Investor’s Intelligence) since 1987, coupled with increasing divergence and deterioration across a wide range of market internals, including small-capitalization stocks, junk debt, market breadth, and other measures. With compressed risk premiums now joined by indications of increasing risk aversion, we remain concerned that risk premiums will normalize not gradually but in spikes, as is their historical tendency.
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This Time Is Different—–For The First Time In 25-Years The Wall Street Gamblers Are Home Alone
The last time the stock market reached a fevered peak and began to wobble unexpectedly was August 2007. The proximate catalyst back then was the sudden recognition that the subprime mortgage problem was not contained at all, as Bernanke had proclaimed six months earlier. The evidence was the surprise announcement by the monster of the mortgage midway—–Countrywide Financial—-that it would be taking huge write-downs on its $200 billion balance sheet.
So here we are once again, and it is once again claimed that this time is different. The 65 month rise of the S&P 500 bears all the hallmarks of a central bank fueled casino—- even more completely than the 2003-2007 run. Also once again, the market is said to be “attractively valued” and that next years earnings(ex-items) at $125 per share represent only a 15X PE multiple. So after the “healthy correction” of the past week or so, it is purportedly time once again to buy the dip.
Except this time is indeed different, but not in a good way. When Bernanke & Co. stalled off the August 2007 correction for nearly a year, they still had plenty of dry powder. The federal funds rate was 5.25% and the Fed’s balance sheet was only $850 billion.
But now, however, we are on the far side of the great monetary experiment known as ZIRP and QE. The money market rate is at the zero bound and has been pinned there for 69 months running—a stretch never before experienced even during the Great Depression. Likewise, the Fed’s balance sheet has grown by 5X to nearly $4.5 trillion—again a previously unimaginable eruption.
But what is profoundly different this time is that the Fed is out of dry powder. Its can’t slash the discount rate as Bernanke did in August 2007 or continuously reduce it federal funds target on a trip from 6% all the way down to zero. Nor can it resort to massive balance sheet expansion. That card has been played and a replay would only spook the market even more.
So this time is different. The gamblers are scampering around the casino fixing to buy the dip as soon as white smoke wafts from the Eccles Building. But none is coming. For the first time in 25- years, the Wall Street gamblers are home alone.
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Global Alert From Chongqing: Foxconn Strike Is An Epochal Inflection Point
Foxconn workers are striking again—this time in Chongqing. But you have to look at the map to see why this is an event of extraordinary significance. In a word, these strikes mean that the rice paddies of China have been nearly drained of cheap, docile labor.
So the strikes in Chongqing are of global and potentially epochal significance. It was the two-decades-long flow of quasi-slave labor into the export factories of east China that enabled the major global central banks to go on a money printing rampage like the world has never before seen. The latter was conducted with apparent impunity because during that same period the induction of several hundred million peasants into the world’s factory system caused worldwide prices of consumer goods to fall, even as the money printers were enabling an orgy of credit-fueled spending by American and European households.
Yes, there is an extensive geography west of Chongqing, but here’s what it mostly consists of: mountains, as in the massive Plateau of Tibet; arid lands, culminating in the forbidding expanse of the Gobi Desert; and the factory-less rain forests of southwest China.
In short, there are few rice paddies west of Chongqing to drain because no one lives there. And this means the closing of the world’s cheap labor frontier is at hand.
Indeed, it had been approaching for several years now as Chinese manufacturers desperately migrated westward, attempting to perpetuate a regime of ultra-cheap factory labor. This perverse arrangement is virtually symbolized by Foxconn’s million plus workers in sweatshops throughout China—factories which keep the likes of Apple, HPQ, Sony, Samsung and all the rest, as well as their American and European customers, in cheap gadgets, cheap electronics and cheap computers. But economically speaking, China’s cheap labor frontier has now it reached its Pacific Ocean equivalent.
In short, the recent age of madcap central bank money printing brought a twin deformation. Its mobilization of the world’s cheap labor reservoir allowed out-of-control central bankers to pull a monetary Alfred E. Neuman. Why worry? There’s no inflation!
Meanwhile, the middle and lower income households throughout the DMs were being wrangled into debt servitude.
And now monumental excess industrial capacity will cause savage price-cutting as competitors scramble to generate enough volume and cash flow to cover the huge fixed costs and bloated balance sheets that attended the global investment boom. The obvious victim will be profit margins throughout the world’s resource extraction and industrial production food chain.
So Chongqing may be far away and hard to pronounce. But the workers striking there are actually marking a crucial inflection point. It is one that denotes the world’s central banks have painted themselves into a corner and that the global economic and financial game of the last two decades is about to change. Big time.
Market Sentiment
Needless to say this is one very expensive stock market with future returns being dismal at best and large draw downs (short term losses) a very real possibility. With high valuation, massive complacency, and central bankers out of ammo (lower interest rates) a decline in the neighborhood 45% to 60% peak to trough is not something to dismiss out of hand. A decline of 60% would place the market only slightly below fair value not coming even close to a secular bottom with PE10 in single digits.
Estimated 10yr return on Stocks
AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION - 10/1/14
10-1-14
Maximum Aggressive Portfolio
(Super Max)
68% Cash - Hussman Strategic Total Return Fund - HSTRX
15% Gold - Tocqueville Gold Fund - TGDLX
7% Lt. Bonds - Zero Coupon 2025 Fund - BTTRX
10% Stocks - Federated Prudent Bear Fund - BEARX
0% REIT'S - REIT Index Fund - VGSLX
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The Great Wait Continue!
DYI
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