A few weeks ago, I covered the latest offering from GMO’s James Montier and Matt Kadnar, who pointed out that the S&P 500 bubble is now trading at its second or third (depending on which measure you use) most expensive level in history.
Using the Shiller P/E, which normalizes earnings from their current value to an approximate trend using a 10-year moving average, the only times’ equities have been more expensive were 1929 and 1999. Meanwhile, according to the Hussman P/E, named after its creator John Hussman, which seeks to provide more accurate reading than the Shiller P/E by normalizing 10-year average earnings to peak earnings, the market is currently in its second most expensive period in history. Only in 1999 was the market more expensive.
S&P 500 Bubble ? market is very expensive
According to John Hussman himself, at the beginning of August, the median price/revenue ratio of S&P 500 component stocks reached the highest level in history, advancing far beyond the levels reached at both the 2000 and 2007 market peaks. Other measures tracked by Hussman and his analysts indicate that the only other time the market was as expensive as it is today was the final high of 24 March 2000.
However, this data is misleading because the one fundamental difference between valuations today and those of 2000 is according to Hussman, "the breadth of overvaluation across individual stocks."
"As of last week, with the exception of the richest decile of stocks, where median valuations were higher only during the January 2000-March 2001 period (followed by median losses exceeding -80% for those stocks), every decile of S&P 500 components is currently at or within 2% of its most extreme valuation in history."
It looks as if it really is the case that this time around it's different.
S&P 500 Bubble: Estimating losses
In 2007 and 2000, Hussman and team warned investors to expect losses based on valuations. At the 2000 peak, he estimated that large-cap technology stocks faced potential losses of approximately -83% over the completion of the market cycle while the prospective loss for the least expensive half of S&P 500 component stocks was only about -25%. By contrast, at the 2007 market peak, stocks were generally overvalued enough to indicate prospective losses of about -55% for all but the very lowest price/revenue decile.
Today, similar losses are projected:
"We presently estimate median losses of about -63% in S&P 500 component stocks over the completion of the current market cycle. There is not a single decile of stocks for which we expect market losses of less than about -54% over the completion of the current market cycle, and we estimate that the richest deciles could lose about -67% to -69% of their market capitalization. As in 2000 and 2007, investors are mistaking a wildly reckless world for a permanently changed one, and their re-education in the concept that valuations matter is likely to be predictably brutal."