May 4, 2015

Two Point Three Sigmas Above the Norm 

John P. Hussman, Ph.D.

While the S&P 500 Index is about 12% above April 2014 levels, my impression is that it may be surprising how quickly that gain is erased as the present cycle is completed. That initial erasure will likely be nothing but a very minor warm-up. At present, the most reliable measures we identify indicate that the S&P 500 is about 128% above the levels that would be historically associated with 10% long-term returns, and imply a net loss, including dividends, for the S&P 500 over the coming decade. Including a broader range of alternate (if slightly less reliable) measures brings that overvaluation to about 114% above historical norms, and results in our expectation of S&P 500 nominal total returns averaging just 1.5% annually over the coming decade.

DYI Comments:  This corresponds with old Ben Graham's work at DYI's pages titled Ben Graham II.  Below is from my page with the formula for determining fair value for the market.

 Value = [10yr-AVG.-IA-EPS] x (8.5 + 2 x G) x (4.4 / Aaa)

Determining Intrinsic Value S&P 500

Current Fair Value 1098 to 1002

Market Overvalued 93% to 111%

Back to Professor Hussman:

For our part, we think a decade is quite a long-time to assume away any event that would provoke investors to demand something close to a normal, run-of-the-mill 10% prospective market return at some point in that decade. Even in depressed interest rate environments, prospective equity returns tend to be weakly correlated with interest rates and rate movements (and are often negatively correlated). The only span in history where the correlation was clearly positive was during the inflation-disinflation cycle from the mid-1960’s to the mid-1990’s. If you’re waiting for stocks to become overvalued by 2 standard deviations, we’re already past that, and we would not be at all surprised to observe another decade of negative total returns on the S&P 500, as we observed the last time valuations were similar on the most reliable measures.

Below is dshort.com chart:

 

DYI Continues:  DYI's model portfolio remains very defensive as our averaging formula has pushed us out of stocks, long bonds, and REIT's only a small position in the gold miners remain.

AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION -  5/1/15

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]

Return of your principal in this overvalued, overblown market is far more important than attempting to speculate for further gains.  In the end these gains will be transitory; for the value player it will be a blink of an eye, the speculator it will seem like eternity waiting for better values.

The Great Wait Continues:

DYI