Former Fed Chair Ben Bernanke: “Having experienced the damage that asset price bubbles can cause, we must be especially vigilant in ensuring that the recent experiences are not repeated.” – Ben Bernanke, Federal Reserve Chair, January 3, 2010
Nowhere
Hussman kicks off his latest post, “Repricing a Market Priced for Zero“, with that quote.
Buckle up, buttercup.
The most challenging financial event for investors in the coming decade will be the repricing of securities to valuations that imply adequate long-term returns, following more than a decade of reckless and intentional Fed-induced yield-seeking speculation.
The chart below updates the status of our most reliable stock market valuation measures, based on their correlation with actual subsequent S&P 500 total returns in market cycles across history. Their historical profiles are largely indistinguishable. The arrow shows the current level of valuation, which remains above every valuation extreme observed prior to 2020. Indeed, our Margin-Adjusted P/E (MAPE), for which a century of data is available, remains beyond its 1929 peak.
Each measure is shown as a ratio to the historical norm associated with run-of-the-mill subsequent S&P 500 total returns of 10% annually. To say that recent market highs approached 3.6 times those historical norms is essentially to say that average S&P 500 total returns are likely to be nowhere near 10% annually during the coming 10-20 years.
Indeed, measured from the recent market peak, I expect S&P 500 total returns to be negative, on average, for well over a decade – an outcome I also projected at the 2000 market peak. That said, if a steep market decline was to front-load those losses, investors could also enjoy prospects for satisfactory long-term returns even a year or two from now. It’s current valuation extremes, and the dismal long-term returns they imply, that long-term investors may want to think twice about locking in.
Hussman Strategic Advisors – We Are Here
Meanwhile, be careful not to interpret valuations as near-term market forecasts. That’s not how valuations work. The main thing that determines whether an overvalued market continues to advance, or drops like a rock instead, is whether investor psychology is inclined toward speculation or risk-aversion. When investors are inclined to speculate, they tend to be indiscriminate about it. When investors become risk-averse, they tend to be skittish and selective. For that reason, our most reliable gauge of speculation versus risk-aversion is the uniformity or divergence of market internals – across thousands of individual stocks, industries, sectors, and security types, including debt securities of varying creditworthiness.
As I wrote at the 2000 bubble peak, “When the market loses that uniformity, valuations often matter suddenly and with a vengeance. This is a lesson best learned before a crash rather than after one. Valuations, trend uniformity, and yield pressures are now uniformly unfavorable, and the market faces extreme risk in this environment.” That’s the same environment we face at present, but as those conditions change, so will our market outlook.
Put simply, the most severe market losses tend to emerge when elevated valuations are joined by deterioration and divergence in market internals, suggesting risk-aversion among investors. Conversely, the strongest opportunities tend to emerge when a material retreat in valuations is joined by broad uniformity in market internals, suggesting speculative psychology among investors.
Year 2000 Flashback
Historical Valuation Norm
Policy Errors
Many observers are hyperventilating about the risks of normalizing Federal Reserve policy, but most of those consequences are unfortunately already baked in the cake after years of speculative recklessness. As I noted in The Fed policy error that should worry investors, the most profound “policy error” of the Fed is well behind it. That error was to abandon, for more than a decade, any systematic link between their policy variables and observable data.
Mish Comments
I encourage anyone who got this far to read the entire Hussman’s article in entirety. It’s loaded with gems.
Many of my readers will complain Hussman has been too bearish.
That’s not at all the case. Hussman never once said “go short” that I am aware.
Rather, Hussman commented on market valuations, I believe accurately. The fact that valuations kept getting more and more extreme does not in the least detract from the message.
The Hook
The hook now is looking at declines and thinking along the lines of “stocks are down 15% so they are cheap.”
Stocks on average will not be cheap if the S&P declines 50% from the top.
If the S&P declines 70% then we can discuss cheap.
Where will support hold?
As I have stated before, I am confident the 4000 level will not hold. I suppose 3200 could hold but more likely it won’t.
But let’s assume it does. The market could meander around that level going “nowhere” for a decade.
It’s more likely for the 2400 level to hold. But that only takes back 5 years of the bull market.
What About Earnings?
It’s not about time or percentage declines per se, but valuations. Earnings still need to catch up.
Both fiscal and monetary policy goosed earnings. That is why Shiller uses CAPE (cyclically-adjusted PE) ratios and Hussman uses MAPE (margin-adjusted PE) ratios.
Earnings mean revert. Most of the forward earnings are total nonsense. They do not reflect higher inflation, higher interest rates, or trade flows which looking ahead will increase costs.
Housing-Adjusted CPI Inflation Hits New Record High Dating to 1987
On April 27, I commented Housing-Adjusted CPI Inflation Hits New Record High Dating to 1987
Home prices disconnected from reality. Regardless of what anyone may think about supply or demand or it’s OK because interest rates are low, that’s an obvious bubble.
And that bubble made people feel wealthy. When you feel wealthy, you spend more money.
The stock market did the same.
Demand destruction looking ahead will not only crush demand, it will raise PEs. This is another reason to distrust forward PEs we see from analysts today.
Cathie Wood’s Ark Open Source Model Predicts Tesla Shares Will Hit $4,600 by 2026
As an example of nonsensical forward earnings estimates, please consider Cathie Wood’s Ark Open Source Model Predicts Tesla Shares Will Hit $4,600 by 2026
Her 2030 model is even more nonsensical. Wood thinks
By 2030 ARK predicts a share price of about $22,500 equating to a market cap of roughly $22.5 trillion.
US Real GDP in 2021 was $19.8 Trillion.
ARK is predicting the valuation of Tesla will exceed the entire US real GDP by the early 2030s.
Yes, this is more than ridiculous. It also says something about ARK’s open source share price model.
Jeremy Grantham Target
Expect More Stock Market Pain Because It’s Coming
I repeat my April 22, 2022 message Expect More Stock Market Pain Because It’s Coming
On February 23, 2022 I commented Most People Have No Idea How Much Stocks are Likely to Crash
In that post I discuss value investor Jeremy Grantham’s thesis on “super bubbles” and his target for the S&P 500.
The post has a link to a Grantham video where he discusses his target.
Those are a few opinions to consider. Whom you believe is up to you.
This post originated at MishTalk.Com.
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Mish
asset price bubbles can cause, we must be especially vigilant in
ensuring that the recent experiences are not repeated.” – Ben Bernanke, Federal Reserve Chair, January 3, 2010
The money that is holding the stock market up doesn’t exist; it is all based on fractional reserve lending; i.e. when lending slows down or even reverses then the effect is bad, real bad.
Simple idea.
Fed prints $10 (through loans) , that $10 is amplified to create $100 worth of money.
Now Fed prints $1 while allowing the previous $10 to get paid back, i.e. net destruction of $9 = $90 worth of money “destroyed”.
It’s not really destroyed but it’s paid back.
In highly leveraged markets (like the stock market), when the leverage is gone, poof goes the valuations.
No leverage means buying at pure cash and no loans. This happened in some housing markets in ’08 and the bottom was really, really low. Most leveraged markets won’t go to pure cash b/c the “lender of last resort”, i.e. the Fed always steps in to prevent the actually bottom from occurring.
Let’s say if the real bottom had been found in ’08, home prices would have reverted to their nominal (not inflation adjusted) mid-1980s pricing.
To see this, just look at Market Cap vs. daily volume, that tells you the daily percentage of people that are actually trading or effectively setting prices. Pricing is set at the margins and if those people who are buying/selling are the marginal buyers that have leverage then pricing is much higher, kill the leverage and the marginal buyers now set the price much, much lower.
Yes, this is more than ridiculous. It also says something about ARK’s open source share price model.”
The Motley Fool had some models like that during the 90s tech bubble. They used to call them “unemotional growth” models or something like that.
All of them had to be ditched in the ensuing bear market, after losing 90 to 95 percent or even more.
Nuclear kookery!