DYI’s
Estimated
Peak to Trough
Decline
55% to 70%
February 13, 2017
John P. Hussman, Ph.D.
The difference between value-conscious investors and speculators is that when they encounter a sign that says “Warning! Dynamite” and see a lit wick at their feet, every inch the wick shortens is a signal for the value investor to step further away.
The speculator instead moves closer, taking the delayed consequences as evidence that it’s different this time, and the sign is wrong.
There have certainly been longer and shorter wicks, but ultimately, the consequences have always arrived.
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."Back to John Hussman:
At present, our estimate based on this and other reliable measures is that the S&P 500 is likely to scratch out a barely positive total return between now and 2029, with all of that gain coming from dividends, leaving the S&P 500 Index itself lower at that date than it is today.
That shouldn’t be a terribly surprising statement. The S&P 500 didn’t durably break its March 24, 2000 high of 1527.46 until March 5, 2013. I expect the completion of the current cycle will not only revisit that level on the S&P 500, but that it will also wipe out the entire total return of the S&P 500 since 2000. Those are the long-term consequences of extreme overvaluation, and they have been throughout history.
Remember that the S&P 500 registered negative total returns for a buy-and-hold strategy for the nearly 12-year period from March 2000 all the way to November 2011. I expect that’s about what we’ll observe from current extremes.
While investors seem eager to lock themselves into passive strategies that have performed well in the rear-view mirror of this climb to obscene valuations, I expect the greatest asset to investors in the coming decade will be adherence to a flexible approach that reduces risk in response to extreme valuation.
And divergent market action, and embraces risk in response to material retreats in valuation that are coupled with early improvements in the uniformity of market action. As I noted last week, my view is that passive, value-insensitive investment strategies are at the beginning of another long winter, while value-conscious, risk-managed, full-cycle investment disciplines are approaching the first day of spring.
DYI:
DYI adheres to the flexible approach or tactical asset allocation as it
has been describe by Jack Bogle the founder of the Vanguard Funds. This is never to be confused with market
timers who jump in or out of the market with majority or in many cases 100% of
their capital. DYI’s allocation is very
slow over years in duration either adding or subtracting depending upon how far
above or below the asset's mean. Simply
put; buying proportionally more below and selling proportionally more above the
mean. Will you out perform the
market? Honestly the best answer is
MAYBE. I will tell you your ride will be
far smoother than a fully invested position where you experience the heights of
ecstasy and the depths of despair experienced on the roller coaster called the
STOCK MARKET!
Back to John Hussman:
These historical relationships between valuations, earnings, margins, and investment returns have several implications. First, Robert Shiller’s “cyclically adjusted P/E” or “CAPE” (S&P 500 divided by the 10-year average of inflation-adjusted earnings) was at 43.5 at the March 2000 peak. By contrast, the current CAPE of 27.4, though higher than the multiple seen at any pre-bubble market peak except 1929, still seems much less extreme. The problem with that simple comparison is that in 2000, the embedded profit margin (the denominator of the CAPE divided by S&P 500 revenues) was just 5.1%, below the historical norm of 5.4%. Presently, the embedded profit margin is 7.4%.
Put another way, on the basis of normalized profit margins, the CAPE in 2000 would have peaked at 41.1, which is less than 10% from the adjusted level of 37.7 that would prevail today on normalized margins.
DYI: Below
I’ve recomputed the EYC Ratio with the adjusted CAPE Rate due to corporate
America’s high flying profit margins.
Unless someone has been living under a rock labor has been screaming about
corporate chiefdoms excessive pay and paltry pay for wage earners. Simply put; highlighting this over inflated
stock market with valuations driven higher due to historically high profit
margins that will regress back to the mean.
Ben Graham's Corner
Margin of Safety!
[ Profit Margin Adjusted CAPE Rate ]
Central Concept of Investment for the purchase of Common Stocks.
"The danger to investors lies in concentrating their purchases in the upper levels of the market..."
Stocks compared to bonds:
Earnings Yield Coverage Ratio - [EYC Ratio]
EYC Ratio = [ (1/PE10) x 100] x 1.1] / Bond Rate
1.75 plus: Safe for large lump sums & DCA
1.30 plus: Safe for DCA
1.29 or less: Mid-Point - Hold stocks and purchase bonds.
1.00 or less: Sell stocks - rebalance portfolio - Re-think stock/bond allocation.
Current EYC Ratio: 0.75
As of 2-14-17
Updated Monthly
Updated Monthly
PE10 as report by Multpl.com
Bond Rate is the rate as reported by
Vanguard Long-Term Investment-Grade Fund Investor Shares (VWESX)
DCA is Dollar Cost Averaging.
Lump Sum any amount greater than yearly salary.
PE10 .........37.7 [ Profit Margin Adjusted CAPE Rate ]
Bond Rate...3.89%
Lump Sum any amount greater than yearly salary.
PE10 .........37.7 [ Profit Margin Adjusted CAPE Rate ]
Bond Rate...3.89%
Over a ten-year period the typical excess of stock earnings power over bond interest may aggregate 4/3 of the price paid. This figure is sufficient to provide a very real margin of safety--which, under favorable conditions, will prevent or minimize a loss......If the purchases are made at the average level of the market over a span of years, the prices paid should carry with them assurance of an adequate margin of safety. The danger to investors lies in concentrating their purchases in the upper levels of the market.....
DYI: Going
to Money Chimp.com their computation model factoring today’s data, average CAPE
Rate (16.72), average growth rate for profits before inflation 5.0%, current
dividend yield 2.0%, AND current adjusted CAPE Rate of 37.7%. Return estimate over the next 10 years? Negative average annual return of -1.20%! OUCH!
THAT HURTS!
To highlight how overvalued the U.S. stock
market how long would an individual or institution have to hold stocks to achieve
a 5% average annual return?
Drum roll
please…
42 YEARS!
That’s fine if you are drinking out of your
sippy cup watching Barney on TV! An
individual 40 or older who has a large lump sum to invest I would certainly
invest a large percentage into short term bonds and a portion into precious
metals mining companies waiting until better values (and future returns) to improve. For that matter a 30 year old
may need to think re-think a fully invested position as life may throw a curve
ball needing these monies at the worst possible time when the market has taken
a tumble of 55% to 70%! Entirely
possible in a scenario as that he or she could very easily be unemployed
quickly running through basic savings.
Updated Monthly
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