John Hussman: Shall We Dance?
“If the parents or the children of Wall Street analysts were to ask for wise investment advice, would the first thought of these analysts really be to encourage stock purchases at a multi-year market high, in a long-uncorrected and strenuously overbought advance, at a multiple of over 18 times earnings on unusually wide profit margins, with wages and unit labor costs rising faster than inflation, while interest rates are rising, bullish sentiment is unusually high, and corporate insiders are selling heavily? Would the potential for further gains in that environment exceed next inevitable correction by an amount that would make the net gains worth the risk? Would they encourage using trend-following systems in an overbought market, even though a decline to simple moving averages already implies substantial losses?
“Uncorrected market advances give a voice to the idea that ‘this time it's different.’ They invariably produce alternate valuation measures (like EBITDA multiples in the 90's, or price/forward operating earnings today) to replace the ones that suggest stocks are overvalued. These new-era arguments prevail despite the fact that the most recent evidence; the most recent market cycle; confirms the relationship between rich valuations and unsatisfactory long-term returns.
“No. We've been here before, and the consequences – though not always immediate – have invariably been bad. There is not a single instance in historical data since 1871 when the S&P 500 traded above 18 times record earnings and there was not a low a year or more later that erased every bit of advantage over Treasury bills. Not one.”
It’s All Fun and Games Until Someone Gets Hurt – February 5, 2007 Weekly Market Comment
Note – the same observation holds for each point that the Shiller P/E (the ratio of the S&P 500 to the 10-year average of inflation-adjusted earnings) was at or above its present level (22.6). Every prior instance in every prior market cycle was followed by a point – at least a year later – where the entire advantage of the S&P 500 over Treasury bills in the interim period was entirely erased. Please understand that that “erased” does not simply mean erased by a margin of 5% or 10%. Rather, the typical resolution put the S&P 500 down 30-60% relative to Treasury bills from the point of overvaluation to the eventual low.
Last week, Investors Intelligence reported that the percentage of bullish investment advisors increased to 54.3%, with bears contracting to 22.3%. Vickers reported that corporate insiders are again selling at a nearly frantic pace of 9.2 shares sold for every share purchased, and the NAAIM survey reported that the average overall equity exposure reported by active investment managers reached 104.25% at the end of January – a leveraged position, and the highest figure in the history of the survey. Indeed, among individual survey participants, the lowest allocation was 60% - the most bullish exposure ever for the most bearish participant in the survey. The previous record in the survey’s history was 96% in early 2007.
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