Tuesday, July 26, 2016

July 25, 2016
John P. Hussman, Ph.D.
There’s a field in one of our data sets that rarely sees much play, being driven primarily by only the most extreme combination of overvaluation, overbullish sentiment, and overbought conditions we’ve identified across history. It’s one of a variety of such syndromes we track, and I’ve simply labeled it “Bubble,” because with a single exception, this extreme variant has only emerged just before the worst market collapses in the past century.

Prior to the advance of recent years, the list of these instances was: August 1929, the week of the market peak; August 1972, after which the S&P 500 would advance about 7% by year-end, and then drop by half; August 1987, the week of the market peak; March 2000, the week of the market peak; and July 2007, within a few points of the final peak in the S&P 500, with a secondary signal in October 2007, the week of that final market peak.
The advancing segment of the current market cycle was different in its response to historic speculative extremes. Air-pockets, panics and crashes had regularly followed these and lesser “overvalued, overbought, overbullish” extremes in every previous market cycle, and our reliance on that fact became our Achilles Heel during the advancing half of this one. In an experiment that will ultimately have disastrous consequences, the Federal Reserve’s policy of quantitative easing intentionally encouraged yield-seeking speculation in this cycle far beyond the point where these warning signals emerged. 
In other cycles across history, patient adherence to a value-conscious, historically-informed investment discipline was rewarded, if occasionally after some delay. In the advancing portion of this cycle, Ben Bernanke’s blind, stubborn recklessness made patient adherence to a value-conscious, historically-informed investment discipline itself indistinguishable from blind, stubborn recklessness. In mid-2014, we adapted our own investment discipline to address this challenge (see the “Box” in The Next Big Short for the full narrative). While lesser overvalued, overbought, overbullish syndromes in 2010 and 2011 were followed by significant market losses, the pattern changed once the Fed drove short-term interest rates to single basis points. In the face of these near-zero interest rates, one had to wait for market internals to deteriorate explicitly (indicating a shift toward risk-aversion among investors) before adopting a hard-negative market outlook.
DYI Comments:   DYI's weighted dividend averaging formula has "kick us out" of the stock market and rightfully so!  Anytime stock prices as measured by the S&P 500 is elevated beyond 100% of its mean dividend yield we are "kick out" of the market.  Today the S&P 500 dividend yield(2.05%) expressed as price to dividends as 49 to 1.  The mean or average dividend yield since 1871 is 4.39% or price to dividends(PD) 23 to 1.  So.  A little easy math (49 - 23) / 23 x 100 = 113% beyond its mean.  This is a very pricey market; so buyer beware!  

DYI for little more than two years has seen itself as the boy who cried wolf only for the townsmen to find no wolf.  What has happened world wide central banks have gone sub atomic low/negative rate crazy followed by more insane QE. This has done nothing more than "jack up" stock and bond prices to absurd levels and has done nothing to help the real economy.  Dismal returns(I'm being polite) are now baked into the cake.

A typical 60% stock - 30% bond -10% T-bills pension fund invested in that allocation held for the next 20 years after all fee's, commissions, trading impact costs, and inflation their return will be around 0% to 2%.  To say this is a horrible time to invest is an understatement.

So hang onto your hats and your cash better values are ahead!
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AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION - 7/1/16

Active Allocation Bands (excluding cash) 0% to 60%
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 0% -Lt. Bonds- Long Term Bond Index - VBLTX
 0% -Stocks- Total Stock Market Index - VTSAX
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