Valuation and Speculation: The Iron Laws 

John P. Hussman, Ph.D.

The first is what I’ve often called the Iron Law of Valuation: every security is a claim on an expected stream of future cash flows, and given that expected stream of future cash flows, the current price of the security moves opposite to the expected future return on that security. The higher the price an investor pays for that expected stream of cash flows today, the lower the return that an investor should expect over the long-term. Particularly at market peaks, investors seem to believe that regardless of the extent of the preceding advance, future returns remain entirely unaffected. The repeated eagerness of investors to extrapolate returns and ignore the Iron Law of Valuation has been the source of the deepest losses in history (see Margins, Multiples, and the Iron Law of Valuation).

DYI Comments:  The U.S. market has been in bubble territory for over two years due to engineered sub atomic low interest rate by the Fed's plus 1st world ageing Baby Boomers investing money into anything with a yield.  Boomer's and the Fed's have driven stock values to the moon. Valuations are so high my weighted averaging formula which provides a great deal of latitude for high valuation markets is now at 0% percent invested.

AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION -  4/1/15

Active Allocation Bands (excluding cash) 0% to 60%

85% - Cash -Short Term Bond Index - VBIRX

15% -Gold- Precious Metals & Mining - VGPMX

 0% -Lt. Bonds- Long Term Bond Index - VBLTX

 0% -Stocks- Total Stock Market Index - VTSAX
 0%-REIT's- REIT Index Fund - VGSLX

[See Disclaimer]

How high is high?  Based on price to dividends the S&P 500 is now 122% above it's average since 1871!  Below is dshort.com based on the average of four methods of valuation to determine how far above or below the market is.  Currently this market is sky high only being out done the year 2000 high tech wreck market.

The Market Remains High in Overvaluation Territory

DYI Continues:  Future returns going forward?  Investing today or holding your current stock holdings going to sleep like Rip Van Winkle waking up 10 years from now what can you expect as an average annual estimated return.  Based on dividends (DYI's favorite) is 1.3%!

Estimated 10yr return on Stocks

Using 5.4% as the historical growth rate of dividends and 4.0% as the ending yield.

Starting Yield*---------return**
1.0%-----------------------(-5.7%)
1.5%-----------------------(-1.7%) 

2.0%------------------------1.3% You are Here!

2.5%------------------------3.8%

3.0%------------------------5.9%
3.5%------------------------7.8%
4.0%------------------------9.4%
4.5%-----------------------10.9%

5.0%-----------------------12.3%
5.5%-----------------------13.6%
6.0%-----------------------14.8%
6.5%-----------------------15.9%

7.0%-----------------------17.0%
7.5%-----------------------18.0%
8.0%-----------------------19.0%

*Starting dividend yield of the S&P500-**10yr estimated average annual rate of return.

Will this 1.3% return be a smooth ride?  Not a chance!  Over the next 10 years there will be one bear market for sure and very likely a second as well.  Please note this return is before management fees, inflation, trading costs and possible taxation.  No doubt the future returns are negative!

Here's our last chart showing more of the same.

DYI