John P. Hussman, Ph.D.
On the basis of valuation measures best correlated with actual subsequent market returns, we can say with a strong degree of confidence that the S&P 500 would presently have to drop to the 940 level in order for investors to expect a historically normal 10-year total return of 10% annually.
That 940 figure for the S&P 500 would not represent some extreme, catastrophic outcome. It’s not a level that would even represent undervaluation from a historical perspective. It’s the level that we would associate with average, historically run-of-the-mill long-term equity returns. As we observed at the 2000 peak, “if you understand values and market history, you know we’re not joking.”
That said, if one believes that depressed interest rates warrant not only a low prospective return on stocks, but also virtually no risk premium whatsoever despite their significant full-cycle volatility, then you might be quite happy with the prospect of a 1.4% annual nominal total return on the S&P 500 over the coming decade,
which is what we presently estimate from current levels, based on a variety of historically reliable methods (see Ockham’s Razor and the Market Cycle for the arithmetic behind these estimates). In that case, you might consider stocks to be "fairly valued" here. But you should still allow for a 940 level or below on the S&P 500 over the completion of this market cycle.DYI Comments: Once again Professor Hussman hits the nail on the head. However one values this market, in an honest fashion, it is overvalued and overblown devoid of value on a wholesale basis. I've been saying for two years plus that the market is setting up for a 45% to 60% smash. The only question is when which has been postponed due to two massive events.
One: Fed intervention on an unprecedented basis with multiple QE, operation twist, reinvestment of interest into addition bond purchases that has resulted in sub atomic low interest rates.
Two: First world Boomer's are desperate to fund their retirement have bid up stock and bond prices to the moon. The nasty one, two punch of Fed intervention and Boomer desperation for yield.
Boomer's savings glut is expected to peak around 2019 to 2021. Does this mean we will have four or more years of overblown and overvalued markets? Honestly, I have no idea (nor does anyone else). Studying, managing money for others(now only for myself) for the past 42 years is this: This is NOT the time to dive into stocks on a whole sale basis and expect to receive anything close to the long term average rate of return (around 10%). The rate of return is not baked into the cake but is a function of the price that is paid for sales, earning and dividends. Higher you pay, the less you will receive and the lower you pay, the higher the return. It's just that simple.
Bonds beware as money catches fire in the US and Europe
Broad M3 money indicators point to a reflationary mini-boom in America and Europe by the end of the year, but be careful what you wish for!
Be thankful for small mercies. The world economy is no longer in a liquidity trap. The slide into deflation has, for now, run its course.
The broad M3 money supply in the US has been soaring at an annual rate of 8.2pc over the past six months, harbinger of a reflationary boomlet by year's end.
Europe is catching up fast. A dynamic measure of eurozone M3 known as Divisia - tracked by the Bruegel Institute in Brussels - is back to growth levels last seen in 2007.
The full force of monetary expansion - not to be confused with liquidity, which can move in the opposite direction - will kick in just as the one-off effects of cheap oil are washed out of the price data. "Forecasters ignore broad money at their peril," says Gabriel Stein, at Oxford Economics.
Mr Stein said total loans in the US are now growing at a faster rate (six-month annualised) than during the five-year build-up to the Lehman crisis. "The risk is that the Fed will have to raise rates much more quickly than the markets expect. This is what happened in 1994," he said.
That episode set off a bond rout. Yields on 10-year US Treasuries rose 260 basis points over 15 months, resetting the global price of money. It detonated Mexico's Tequila crisis.
US bond markets are equally vulnerable. Investors are pricing in rates of 0.9pc by the end of 2016, compared with 1.875pc by the Fed itself. This is extraordinary. The St Louis Fed's James Bullard could hardly have been clearer on a recent trip to London.
“I think reconciliation between what markets think and what the committee (FOMC) thinks will have to happen at some point. That's a potentially violent reconciliation," he said.
It is not as if the Fed is hawkish. It is rightly wary of tightening with the labour participation rate still stuck at a 40-year low of 62.7pc. Yet the market is turning. The quit rate - a gauge of willingness to look for a better job - is nearing 2pc, the level when employers must build pay-moats to keep workers.
The greater threat - muttered sotto voce at the IMF Spring meeting this week - is that the Fed will soon be forced to hit the brakes hard, throwing dollar-debtors through the windscreen across the emerging world.
The official line is that all is under control. There will be no repeat of the "taper tantrum" in 2013. Behind the scenes, IMF officials acknowledge that it may be worse, a full-fledged margin call on $9 trillion of external dollar borrowing, much of it by companies in China, Hong Kong, Brazil, Mexico, South Africa and Russia. They fear too that it will combine with a nasty unwinding of East Asia's internal credit bubble.
DYI Comments Continue: Going back to Professor Hussman.
Last month, Stan Druckenmiller recounted his own experience with capitulation and performance chasing when he was the lead portfolio manager for George Soros and the Quantum Fund:
“I’ll never forget it. January of 2000 I go into Soros’ office and I say I’m selling all the tech stocks, selling everything. This is crazy... Just kind of as I explained earlier, we’re going to step aside, wait for the next fat pitch. I didn’t fire the two gun slingers. They didn’t have enough money to really hurt the fund, but they started making 3 percent a day, and I’m out. It’s driving me nuts. I mean, their little account is like up 50% on the year. I think Quantum was up seven. It’s just sitting there.
“So like around March I could feel it coming. I just – I had to play. I couldn’t help myself. And three times during the same week I pick up a – don’t do it. Don’t do it.
Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks, and in six weeks I had left Soros and I had lost $3 billion in that one play.
You ask me what I learned. I didn’t learn anything. I already knew I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself. So maybe I learned not to do it again, but I already knew that.”
OR
J. Paul Getty Quote!
Stock Market - "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 Continues: Will this market end in a speculative blow off similar to the high tech wreck dot bomb market of 2000? No one knows for sure history is more on the side of a market blow off of some kind. Or will it be that Boomer's begin to retire in significant numbers and valuation slide downward over a long period of time as in Japan? However this plays out now is not the time for whole sale purchases of stocks or long term bonds especially junk. It is the boring time to build cash (short term bonds) and some gold.
AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION - 4/1/15
[See Disclaimer]The Great Wait Continues
DYI
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