John Hussman Confidence Abounds
Worth noting is that in historical data since 1871, there is only a single month prior to the late-1990’s bubble when valuations were richer than they are today, based on either the Shiller P/E (S&P 500 divided by 10-year inflation adjusted earnings) or my old price/peak-earnings ratio (which takes record earnings at face value – but at least consistently so – by dividing the S&P 500 by the highest level of earnings achieved to-date). That month was August 1929. Valuation itself is not a useful timing tool, but a century of history goes against the delusion that present levels can be expected to produce positive total returns in the S&P 500 on horizons of less than 7 years. Importantly, the most reliable props that have historically allowed the market to turn a blind eye to valuation have been missing for some time now.
Given the unfortunate resolution of similarly extreme overvalued, overbought, overbullish, rising-yield periods in history, it’s almost mind-boggling that investors actually expect the present speculative run to end well. The accelerating pitch and shallowing corrections of the recent advance are worth noting. As I wrote about the oil market in July 2008 as prices raced toward $150 a barrel (see The Outlook for Inflation and the Likelihood of $60 Oil) “Geek’s Rule o’ Thumb: When you have to fit a sixth-order polynomial to capture price history because exponential growth is too conservative, you’re probably close to a peak.” Oil prices collapsed as low as $35 a barrel shortly thereafter. The preceding advance to the speculative peak was very well-described by a “log periodic bubble” of the sort that characterizes the S&P 500 at present (see Increasingly Immediate Impulses to Buy the Dip … or How to Blow a Bubble).
Based on the fidelity of the recent advance to this price structure, we estimate the “finite-time singularity” of the present log-periodic bubble to occur (or to have occurred) somewhere between December 31, 2013 and January 13, 2014. That does not mean that prices must immediately crash – only that the dynamics will then lend themselves to a great deal of potential instability, if prior log-periodic bubbles in equity and commodity markets across history are any indication. It bears repeating that our own defensiveness is driven by a broad ensemble of evidence, not simply price dynamics, not simply valuations, not simply sentiment, but the “full catastrophe” – which includes the fact that strong economic, speculative and monetary enthusiasm has historically been quite a contrary indicator for stocks.
The chart below shows the current position of the S&P 500. The light red line shows the log-periodic price trajectory that most closely approximates the present overvalued, overbought, overbullish, Fed-induced speculative run since 2010. While the initial gains from the 2009 low until about mid-2010 represented what we view as a move from reasonable valuation to full valuation (our stress-testing “miss” was not on valuation grounds), I expect little, if any of the market’s gains since 2010 to be retained by investors over the completion of this market cycle. Despite very short-run uncertainties about market direction, I should note that we now estimate negative prospective total returns for the S&P 500 on every horizon of less than 7 years.