Measuring the Bubble

John P. Hussman, Ph.D.

President, Hussman Investment Trust

February 2018

DYI:  Once again Professor John Hussman knocks it out of the park illustrating in his extensive article how monstrously overvalued the U.S. market is.  Old John is anticipating from peak to trough decline of 66%!  Here at DYI I’m expecting within a range of 60% to 75%!  It would appear Hussman is the optimist.  What must be placed on the table this total peak to total trough may take more than one cycle so aptly displayed by the Japanese market.

  

Nikkei 225 as of 1-31-18

23,098

The Nikkei 225 appears to have bottomed out in 2009; two decade long bear market with a classic double bottom.  Wow!  Could this happen here?  It is possible – that is why I’ve placed this possibility on the table – the U.S. market is coming off of a double secular top (year 2000 and now).

Fred's Intelligent Bear Site brought to you by Fred Filskov. Public, private, and commercial distribution of this material is permitted as long as a link to this site is attached.  This chart is one year out of date but clearly due to the Trump rally we have now achieved a double secular top!

Correct the Shiller PE¹⁰ for the insanely high profit margins and presto change-o you are now spouting 50 times Shiller.  Wow! Wow!  This has the market 197% above the average! Wow! Wow! Wow!  If we go to a typical secular bottom at 10 times Shiller PE¹⁰ the drop would be 80%!  Wow⁴!

Dollar cost averager’s (DCA) have stated many times they have a leg up on value players.  Simply buy every pay period a portfolio of common stocks – an index fund – and let DCA do its magic. Here is a statement from someone writing in on a different economic/investing web site discussing value players vs. DCA.  And by the way his math is correct:

 "Here's what money managers and bloggers never tell you. If you bought the NASDAQ in Mar 2000, the absolute peak of Dotcom bubble, and put $100 per month every into a low cost fund your return per year over the last 19 years is 10.7%/yr. or 201%." And what will it be if the NASDAQ crashes 78% a second time?

As of 1-31-18

6974.50

OK.  Let’s break this down and remember – figures don’t lie but statistics do. Before I break this down here is a quote from the late Benjamin Graham:

"The danger to investors lies in concentrating their purchases in the upper levels of the market..."

This is a clear case of cherry picking data whether by design or accident.  Starting at the ultimate top of a market that experienced a complete washout – that is what a 78% decline does.  The majority of his purchases – 12 years out of 19 – were at the “lower levels of the market” and those that didn’t from 2013 on the NASDAQ continued at a blistering upside pace ending his average compounding return on a high note.  The reason is clear for the great return 58% of his purchases were at the lower levels of the market before the scorching returns at the tail end from 2013.  DCA is great tool but like any tool it has to be used correctly and only purchase stocks at the lower levels of the market.

Once this market goes south our DCA investor's overall high return of 10.7% will evaporate faster than a pool of water in the Gobi desert.  Without the understanding of value your future returns whether great, poor or something in between will only be a function of luck.  If you were a 30 year old plowing money into a stock fund starting in say 1975 [and yes I’m cherry picking] by year 2000 his opinion stock buying is easy and very profitable.  Another 30 year old who starts in 1990 until today would find stock buying neither easy nor profitably robust.   

Margin of Safety!

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: 0.90 (rounded)

As of 2-1-18
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  .........34.15
Bond Rate...3.59%

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.....

Common Sense Investing:
The Papers of Benjamin Graham
Benjamin Graham

Investor legend the late John Templeton who coined the 2000 top as The Great Insanity should we call today’s market – The Era of Fools?

  DYI