John P. Hussman, Ph.D.
All rights reserved and actively enforced.
On the basis of a broad range of valuation measures that are tightly (nearly 90%) correlated with actual subsequent S&P 500 total returns over the following decade, we estimate that stock prices are about double the level that would generate historically adequate long-term returns. The chart below presents estimated versus actual 10-year S&P 500 total returns using a variety of methods that I’ve detailed in prior weekly comments, and including a few additional ones for good measure. We presently estimate 10-year S&P 500 nominal total returns of only about 2.7% annually over the coming decade, with negative returns on all horizons shorter than about 7 years.
These are, of course, the same methods that allowed us – in real time – to project negative 10-year total returns for the S&P 500 in 2000 even under optimistic assumptions, to identify severe overvaluation in 2007, and to quantify the shift to reasonable valuations in late-2008 and 2009 (our stress-testing response to the credit crisis was emphatically not based on valuation). Note also that valuations are not the sole driver of our investment stance, as should be clear from our shift to a favorable market outlook in early 2003, following the 50% market plunge in 2000-2002.
Fortunately, the prospect of awful market returns and steep downside risk from present market levels certainly does not imply a lack of opportunities over time. Valuations adjust, and market conditions change. I fully expect to observe outstanding investment opportunities over the completion of the present market cycle and the next, even if a moderate retreat in valuations leaves them well above historical norms (as we saw in 2003). Now is not the moment to feel rushed to commit capital to a Fed-induced speculative carnival.
Needless to say, Wall Street wishes investors to believe that valuations are just fine, and one can hardly watch CNBC for 10 minutes without some reference to stocks being “cheap on forward earnings.”