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Hussman Weekly: Puppet Show

January 22, 2013

Last week, the S&P 500 advanced the extra 1% required to re-establish virtually every “overvalued, overbought, overbullish, rising-yields” syndrome that we define – syndromes that have appeared at or close to the beginning of what investors can easily recall as the singularly worst set of market instances in history, including the 1973-74, 1987, 2000-2002, and 2007-2009 plunges. With some minor imputation (estimating bullish and bearish sentiment as a function of the extent and volatility of prior market movement), we can verify that these syndromes also emerged just prior to the 1929-1932 collapse. The S&P 500 is presently near or through its Bollinger band (2 standard deviations above its 20-period moving average) at daily, weekly and monthly resolutions, the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) is above 22, Investors Intelligence reports lopsided sentiment at 53.2% bulls versus 22.3% bears, the S&P 500 is well into a mature bull market and Treasury bond yields have advanced measurably.

The blue lines over the chart of the S&P 500 below are even sparser than our typical charts of "overvalued, overbought, overbullish, rising-yield" events, and identify the points where the S&P 500 was within 3% of its upper Bollinger bands, at least 7% above its 52-week smoothing, and over 50% above its 4-year low, with bulls above 52% and bears below 27%, a Shiller P/E above 18, and 10-year Treasury yields above their level of 6-months earlier. As I often note, there are numerous ways of defining syndromes like this. The conditions here are essentially a way of identifying what have normally been the most strenuously overvalued, overbought, overbullish, rising-yield points within already mature market advances. Investors who are willing to accept present, record profit margins (about 70% above historical norms) as permanent will reject the notion that stocks are overvalued, but I trust that the evidence we’ve presented over time underscores the deeper basis for that conclusion. See last week’s comment Declaring Victory at Halftime for the relationship between profits as a share of GDP and subsequent earnings growth, Too Little to Lock In for the link between deficit spending and corporate profits, and Overlooking Overvaluation for the relationship between various valuation metrics and subsequent market returns.


For optimists, there is a false one-week signal in 1997 – during the internet bubble – that was not associated with a negative follow-through. That is, as long as one ignores that the S&P 500 was essentially unchanged 5-years later, underperformed Treasury bills for the next 12 years, and even through last week’s advance, has outperformed Treasury bills by less than 2% annually in the nearly 16 years since then (all of which would be surrendered by even a run-of-the-mill bear market decline – and then some). There is also a fairly uneventful signal in mid-1964 that was not followed by near-term losses, though the market was still lower two years later and would underperform Treasury bills for the next 20 years.

Notably, during the recent bull market advance, we’ve seen conditions as extreme as at present only once – in early 2011, just prior to a nearly 20% market loss, though not rivaling the 30-50% plunges that this syndrome has also captured.

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