Excerpted from John Hussman's Weekly Comment,
“The gods had condemned Sisyphus to ceaselessly roll a stone to the top of a mountain, whence the stone would fall back of its own weight. At the very end of his effort measured by skyless space and time without depth, the purpose is achieved. Then Sisyphus watches the stone rush down in a few moments toward that lower world whence he will have to push it up again toward the summit. If this myth is tragic, that is because its hero is conscious. Where would his torture be, indeed, if at every step the hope of succeeding upheld him? … Sisyphus, proletarian of the gods, powerless and rebellious, knows the extent of his wretched condition: it is what he thinks of during his descent.”
After little more than a year of legitimate revaluation of equities following the 2007-2009 credit crisis, and more than three years of what will likely turn out to be wholly impermanent – if dazzling – Fed-induced speculation, investors have again pushed the stone to the top of the mountain. Despite the devastating losses of half the market’s value in 2000-2002 and 2007-2009, investors experience no fear – no suffering as a result of present market extremes. There is no suffering because at every step, as Camus might have observed, “the hope of succeeding” upholds them.
As we discussed several months ago, that hope of succeeding rests on what economist J.K. Galbraith called “the extreme brevity of the financial memory.” Part of that brevity rests on ignoring the forest for the trees, and failing to consider movements further up the mountain in the context of how far the stone typically falls once it gets loose. It bears repeating that the average, run-of-the-mill bear market decline wipes out more than half of the preceding bull market advance, making the April 2010 S&P 500 level in the 1200’s a fairly pedestrian expectation for the index over the completion of the current market cycle. A decline of that extent wouldn’t bring valuations close to historical norms, and certainly not to levels that would historically represent “undervaluation.” But consider that a baseline expectation, and don’t be particularly surprised if the market loses closer to 38% - which is the average cyclical bear market loss during a secular bear market period. A market loss of about 50% would put historically reliable valuation metrics at their historical norms, though short-term rates near zero would seem inconsistent with a move to historically normal valuations with typical (~10% annual) expected total returns, absent other disruptions.
The simple fact is that the completion of the present market cycle might be better, or it might be worse than historic norms. We know that we don’t want to speculate here in any event, but neither a severe market loss nor a move to “undervaluation” is a requirement for us to encourage market exposure. For our part, we would expect to shift to a significantly constructive position on a meaningful retreat in valuations – even if to still-overvalued levels – coupled with an early improvement in key measures of market internals.
The charts below display various journeys of Sisyphus - a chronicle of multi-year, increasingly speculative market advances that terminated in the same set of conditions that we presently observe. The charts show only the advance to the highs. So for example, the chart below of the advance to the 1929 high does not feature the 85% market plunge that followed, the chart for 1987 does not feature the subsequent crash, and the charts ending in 1972, 2000 and 2007 do not feature the 50% market plunges that followed. Then of course, there is the chart through last week which, we are assured, is entirely different from the others.
Examine these charts carefully, and ask yourself if you would have had any less confidence in the “strength” and “resilience” of the market at these pinnacles than investors appear to have today.
We can view the journeys of Sisyphus in these charts with an understanding of why investors felt no discomfort, despite the fact that they were about to lose a significant fraction of their assets. As Camus asked, “Where would his torture be, indeed, if at every step the hope of succeeding upheld him?”
Is this time materially different from 1929, 1972, 1987, 2000, or 2007? We doubt it. In the chart of overvalued, overbought, overbullish extremes below, I’ve replaced the Shiller P/E (which is a lightning rod) with a variant that I introduced in the 1990’s, basing the P/E multiple on the highest level of trailing earnings observed to-date – surely an optimistic and forgiving measure today given that profit margins are about 70% above historical norms, but one that signals rich valuation regardless. We certainly can’t rule out movements further up the mountain (though to us, 2013 was largely a replay of 1999), but those movements are likely to appear small in the context of what will be erased over the completion of the cycle.
Despite the inevitability of the descent of Sisyphus’ stone following these peaks, that inevitability should be the source of great optimism – not for current opportunities, but for future ones. Those with fidelity to informed discipline need only remain in the present moment, responding to the evidence as it changes, without needing to judge advances or declines as fortunate or unfortunate. The benefits of that discipline emerge over the course of the cycle even if some events seem unwelcome. Likewise, the existentialist Camus understood the cycle of things, and properly recognized the value of even the descent, without needing to judge it as tragic:
“If the descent is thus sometimes performed in sorrow, it can also take place in joy. There is no sun without shadow, and it is essential to know the night. I leave Sisyphus at the foot of the mountain! One always finds one’s burden again. But Sisyphus teaches the higher fidelity that negates the gods and raises rocks. The struggle again toward the heights is enough to fill a man’s heart. One must imagine Sisyphus happy.”