Here are the highlights from Hussman’s weekly letter. I’ve picked out the key points:
Present market conditions join the second most extreme valuations in U.S. history (on measures most reliably correlated with actual subsequent 10-year S&P 500 total returns) with increasing divergences and dispersion in market internals. On that front, market conditions presently (and in recent quarters) support a hard-defensive outlook that’s largely identical to those we took in 2000 and 2007. The same return/risk profile has been associated with vertical market losses in market cycles across history. The chart below shows the cumulative total return of the S&P 500, restricted to the 8% of historical periods with an estimated return/risk profile matching what we presently observe.
Presently, the valuation of the S&P 500 is within about 16% of the 2000 peak, on the most historically reliable measures we identify. Moreover, valuation extremes were only greater in 2000 on capitalization-weighted indices. Today, the median stock is more richly valued than at any point in U.S. history, including 2000.
The Federal Reserve hasn’t created a perpetual money machine. No, no, no, no, no. What the Fed has done is to encourage investors to chase yields and to speculate, to the point where stocks are now so overvalued that they can be expected to enjoy no further return at all over the coming decade. That’s how security pricing works. The higher the price an investor pays for a given stream of future expected cash flows, the lower the subsequent return an investor can expect to enjoy. The gains have already been had, at least on paper, though the holders who successfully realize these paper gains will do so through a needle’s eye.
The past few quarters appear to be part of that distribution process. Volume picks up as holders attempt to sell and those shares are absorbed by dip-buyers, followed by low-volume short squeezes as sellers back off, and then return after those rallies with additional rounds of distribution. As long as only a few investors attempt to do so, any individual can cash out, but only by successfully selling their shares to some other investor at current levels. In aggregate, investors can’t exit, because somebody has to hold the stuff. For most investors, the majority of the paper gains that have emerged during the advancing half-cycle since 2009 will simply vanish over the completion of the cycle.
As in equal or lesser speculative bubbles across history, there’s a common delusion that elevated stock prices represent wealth to their holders. That is a fallacy, and we can hardly believe that given the collapses that followed the 2000 and 2007 extremes, investors (and even Fed policymakers) would again fall for that fallacy so readily. The actual wealth is in the cash flows that are ultimately delivered into the hands of shareholders over time. Individuals can realize their paper wealth by selling now to some other investor and receiving cash in return, but only a small proportion of investors can actually convert current paper wealth into cash by selling to other investors without disrupting the bubble. The new buyer then receives whatever cash flows the stock delivers into the hands of existing holders, and can eventually sell the claim to the remaining stream of future cash flows to yet another investor. Ultimately, a share of stock is nothing but a claim on the long-term stream of cash flows that will be delivered into the hands of its holders over time. The current price and the future cash flows are linked together by a rate of return: the higher the price you pay today for a given stream of future cash flows, the lower the rate of return you can expect achieve by holding that investment over the long-term.
There’s not a single market cycle in the historical record where the ratio of market capitalization to corporate gross value added (GVA) did not fall to about half the level that we observe today (or lower). Our view is that the level of the S&P 500 today is currently higher than the level investors will observe a decade from today, but dividends should make up the difference to provide an expected total return of roughly zero. In a zero return world, some may see this hypervaluation as “fair” – and those investors are free to call stocks “fairly valued relative to interest rates.” But the prospective 10-year return on the S&P 500, from current price levels, is still likely to be zero based on the most reliable valuation measures we identify.
Zero based? How about in way LESS than 10 years, plain old Zero, zilch, nada, notting…investors, pensioners, future retirees, everybody but Banksters get skinned alive (not just a haircut). .
Damn it, stocks rise when two people agree (a buyer and a seller) that the price should be higher, and everyone else’s shares rise in sympathy….no effort or action required.
In this regard, higher and higher valuations are simply Groupthink, a product of mass psychology.
This expansive Groupthink causes stock wealth to rise mostly by increasing the prices of stocks, not as much the quantity of stock shares.
The effect in the bond market is not so much that bond prices rise (they did) but that people keep accepting another IOU, and another and another and another, from increasingly shaky borrowers.
Today we have stocks priced like Nirvana has arisen, and we have bonds flooding into an ocean because EVERYONE WILL ALWAYS PAY THEIR DEBTS.
None of this is possible.
A vast re-valuation of stocks must happen (prices collapse) and a vast shrinkage of the ocean of IOU’s must occur (both as prices fall and as individual IOU’s themselves are repudiated entirely in bankruptcy.)
The wealth in which we appear to swim today came from NOWHERE.
It will return to NOWHERE.