J. Paul Getty Quote! 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.

July 3, 2017

Mesas, Valleys, Plateaus, and Cliffs

John P. Hussman, Ph.D.

In recent decades, we’ve seen the same kind of mesa formations in the equity market; points where historically extreme valuation bubbles temporarily draw S&P 500 10-year returns well above levels that would have been projected on the basis of valuations a decade earlier, with vertical plunges taking returns back to earth as valuations are restored.

Modest patterns like that are normal, but at the 2000 valuation extreme, and again today, they have been taken to levels that history will remember as monuments to speculative recklessness.

DYI:  I feel as if I’m the boy who cried wolf and yet the market continues to power ahead moving valuations higher and higher.  Yet we all know, or should know, as valuations climb future returns are inversely correlated.  Higher the valuation lower expected future returns.  The U.S. market as measured by the Shiller PE¹⁰ is at the nose bleed level of 29.66!

Shiller PE ratio as of June 30, 2017....29.66

Stocks held or purchased today go to sleep like Rip Van Winkle waking in 12 years time your expected return with dividends reinvested is….drum roll please…positive 2.02%!  Assuming the market ends at its average of 16.76!  Houston we have a problem. PE¹⁰ valuation above the average since February 1991 except for a brief seven month moment from 2008 – 2009 time period, hence market valuation above its mean for over 25 years!  Unless you believe stocks have now reached a new permanent plateau moving the average up dramatically, stocks are poised to begin their journey of valuation below their long term average.  Using my Rip Van Winkle 12 year approach PE¹⁰ ending at 10 your return….drum roll please…negative average annual return of 2.19%! OUCH!

So…if you agree with my analyses what is an investor to do?  Look to other assets that are dramatically different or as stated in finance terms – uncorrelated assets – that rise and fall from different economic forces.  The late Harry Browne pioneered uncorrelated assets with his Permanent Portfolio concept of four assets – stocks, long term bonds, gold, and cash (short term notes).  His approach is a constant or fixed asset allocation of 25% into each category of assets rebalancing only when one of the assets moves 15% or more.  Simple concept and it works quite well for the fixed asset ultra defensive investor.  DYI has applied well known averages for stocks, long term bonds, and gold (gold mining companies) with cash being a holding area or bull pen.  From a fixed to active asset allocation model or in other words one or two of these three assets will be in a bull market with a bulk of your dollars participating.  How is this done?  Apply the same averaging formula to stocks, long term bonds, and gold.  Just simply look to the top of my blog and click on stock, bonds, gold for a complete explanation.  Cheers!

  DYI