Mark Yusko, CEO and Chief Investment Officer of Morgan Creek Capital Management, recently published his 4Q 2013 Letter to Investors. Mark Yusko uses a Shakespearean analogy to structure his arguments that today’s euphoric equity markets are overvalued by almost any reasonable valuation. He eloquently proffers 10 reasons why he “hates” current equity markets.
Mark Yusko: I hate your overvaluation
Mark Yusko’s first point is more of an overview of the arguments he lays out below. “There are multiple ways to look at valuation of the equity markets and the chart here shows three different measures that are all flashing red, with an average level of overvaluation at 67%.”
I hate your really high P/E
The Morgan Creek report argues that P/E ratios are dangerously high on an historical basis. “The current cycle has moved the forward P/E up 50% and the current value is 15.9.Comparing the current level of the long-term averages shows meaningful overvaluation as well, with the 10-year average at 14.1 and the 35-year average at 12.6.”
I hate your extended Buffett indicator
Mark Yusko also points to a valuation metric supposedly championed by legendary investor Warren Buffett. “Total equity market cap/GDP of a country has been a good indicator of the overall valuation of markets. The ratio has a central tendency of 0.7, approximating Fair Value, and levels below 0.5 would be considered cheap and levels above 1.0 would be considered expensive. The current reading of 1.18 is quite high with the only higher levels seen during the Tech Bubble.”
I hate your future negativity
Negative Real Return, a valuation system developed by GMO, is also flashing red. “The last time there was a Negative Real Return forecast for the S&P 500 was in 1999 and the subsequent returns for the equity market were indeed negative over the ensuing period including negative returns in each of the next three calendar years and a cumulative loss of nearly (40%).”
I hate how you’ve hit resistance
Mark Yusko also highlights how technical indicators could also be auguring a slump in the equity markets. “Market technician Chris Kimble has shown that before each of the last three major equity market corrections the 10-year Treasury has encountered the resistance line shown in this chart. The Treasury market has recently bounced off that resistance line again and could be signaling a meaningful turn down in the equity markets.”
I hate how everyone has gone All-in
Yusko also focuses on too much bullish sentiment about the markets as a negative indicator. “Investor Sentiment has long been used as a contrarian indicator of market movements. Specifically, when individual investors are Bullish, that is Bearish for equities and vice versa. The recent AAII surveys show some troubling signs, first that individual investors have only had more exposure to stocks during the Tech Bubble, which is a clear Bearish signal.”
I hate your record Bull-Bear ratio
The report also highlights the current record Bull-Bear ratio as a contrarian indicator. “Another contrarian signal is the II Survey that asks investors whether they are Bullish or Bearish at the current time. The more Bears there are, the more Bullish the signal and vice versa. This chart is a true “Hater” as we have never seen a higher Bull/Bear ratio than today (including the tech Bubble…) at a stunning ratio of over 4:1.”
I hate that insiders see no bargains
Yusko says insider selling is another flashing red light. “We haven’t seen insider selling like this since the Tech Bubble, so caveat emptor (buyer beware).”
I hate the extreme Vol compression
The growing volatility in the markets and the rise in the VIX index are also a cause for concern, according to Yusko. “It appears we are very close to an extreme reading in the VIX Index and those extreme readings have historically been followed by volatility.”
I hate your Singularity
Finally, Yusko argues that the shortening up-and-down cycles we have witnessed over the last few quarters could be harbingers of a market crash. “[John Hussman] devised the Bubble Model in this chart many months ago to show what a “textbook” mania would look like. Interestingly, this model reflects the shortening of cycles that I have talked about in many previous letters. The frenetic gyrations toward the end of the Bubble graph reflect the schizophrenic, emotional, panic buying/selling…”
