All Their Eggs in Janet's Basket 

John P. Hussman, Ph.D.

The financial markets are establishing an extreme that we expect investors will remember for the remainder of history, joining other memorable peers that include 1906, 1929, 1937, 1966, 1972, 2000 and 2007.

 

The failure to recognize this moment as historic is largely because investors have been urged to believe things that aren’t true, have never been true, and can be demonstrated to be untrue across a century of history.

The broad market has been in an extended distribution process for nearly a year (during which the NYSE Composite has gone nowhere) yet every marginal high or brief market burst seems infinitely important from a short-sighted perspective.

 

Like other major peaks throughout history, we expect that these minor details will be forgotten within the sheer scope of what follows. 

And like other historical extremes, the beliefs that enable them are widely embraced as common knowledge, though there is always, always, some wrinkle that makes “this time” seem different. 

That is why history only rhymes. But in its broad refrain, this time is not different.

 Let’s get my subjective narrative out of the way so we can focus on the objective evidence. My own stumble in the half-cycle since 2009 – and it was a serious one – was to insist, after a financial collapse that we had anticipated, on stress-testing our methods of classifying market return/risk profiles against Depression-era data. 

During the tech bubble, we recognized that deterioration in market internals and other risk-sensitive measures such as credit spreads is the central feature that distinguishes an overvalued market that continues to advance from an overvalued market that collapses. 

The broad behavior of market internals (what I used to call “trend uniformity”) is effectively a measure of investor risk-preferences, and increasing divergence and dispersion is a signal of emerging risk-aversion among investors.

Again, it’s not simply extreme valuation, but the fact that extreme valuation is now joined with deteriorating market internals and widening credit spreads, that drives my rather unrestrained concerns here. Despite wicked valuations, an improvement in market internals and credit spreads would convey a signal about fresh risk-seeking among investors and would substantially ease the immediacy of those concerns.

DYI Comments: High Yield (Junk Bonds) Interest rates have moved upward as compared to investment grade bonds only to the point to where one's eyebrows move upwardly.  A cause for concern but not enough pressure as yet to show a trend towards risk aversion.  

Generational Dynamics

Wall Street stocks have surged further into bubble territory as well during the last year, just like Shanghai stocks, though they have not yet taken any serious plunge like the Shanghai stock exchange. 

It's been a month since I reported that the S&P 500 Price/Earnings ratio (stock valuation index) was at an astronomically high 21.47 on May 15, indicating a huge stock market bubble. Since then it's shot up further to the ever more astronomical level of 21.73, according to the Wall Street Journal on Friday, June 19.

  

21.73 is far above the historical average of 14. Furthermore, it was 18 just a year ago, and has been increasing rapidly since then, indicating that the Wall Street stock market bubble is accelerating, just as the Shanghai stock market bubble has been accelerating during the last year. Generational Dynamics predicts that a panic will occur, and that the P/E ratio will fall to the 5-6 range or lower, which is where it was as recently as 1982, resulting in a Dow Jones Industrial Average of 3000 or lower.

DYI