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Do The Lessons Of History No Longer Apply?
Excerpted from John Hussman's Weekly Market Comment,
Is this time different? I’ve often characterized our approach to the financial markets as a value-conscious, historically-informed, evidence-driven discipline. In recent years, we’ve often been asked whether the world has changed in a way that makes historical evidence an inadequate guide to investing.
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In some cases, those learnable regularities can be derived on the basis of clear theoretical relationships that describe how the world works with reasonable accuracy.
For example, every long-term security is fundamentally a claim on a very long-duration stream of cash flows that can be expected to be delivered into the hands of investors over time. For a given stream of expected cash flows and a given current price, we can quickly estimate the long-term rate of return that the security can be expected to achieve (assuming the cash flows are delivered as expected). Likewise, for a given stream of expected cash flows and a “required” long-term rate of return, we can calculate the current price that would be consistent with that long-term rate of return. The failure to understand the inverse relationship between current prices and future returns is why investors frequently argue that rich equity valuations are “justified” by low interest rates, without understanding that they are really saying that dismal future equity returns are perfectly acceptable.
We also observe the very regular tendency for profit margins to increase during economic expansions (presently corporate profits are close to 11% of GDP), and to contract during softer periods. Corporate profits as a share of GDP have always retreated to less than 5.5% in every economic cycle on record, even in recent decades. Since stocks are most reliably priced on the basis of long-term cash flows, and not simply Wall Street’s estimate of next year’s earnings, we find that valuation measures that are either relatively insensitive to profit margin swings, or that correct for their variation over the economic cycle, are much better correlated with actual subsequent market returns than measures such as price/forward operating earnings that don’t do so.
Our valuation concerns don’t rely on any requirement for earnings or profit margins to turn down in the near term. Valuations are a long-term proposition that link the price being paid today to a stream of cash flows that, for the S&P 500, have an effective duration of about 50 years. In evaluating whether “this time is different,” it should be understood that current valuations are “justified” only if 1) the wide historical cyclicality of profits over the economic cycle has been eliminated, 2) the average level of profit margins over the next five decades will be permanently elevated at nearly twice the historical norm, 3) the strong historical advantage of smoothed or margin-adjusted valuation measures over single-year price/earnings measures has vanished, and 4) zero interest rate policies will persist not just for 3 or 4 more years, but for decades while economic growth proceeds at historically normal rates nonetheless. Believe all of that if you wish. Without permanent changes in the way the world works, on valuation measures that are best correlated with actual subsequent market returns, stocks are wickedly overvalued here.
The chart below show several of the measures that have the strongest relationship (correlation near 90%) with actual subsequent 10-year S&P 500 total returns, reflecting data from the Federal Reserve, Standard & Poors, Robert Shiller, and valuation models that we have published over the years.
As of last week, based on a variety of methods, we estimate likely S&P 500 10-year nominal total returns averaging just 1.5% annually over the coming decade, with negative expected returns on every horizon shorter than about 8 years. The chart above shows the historical record of these estimates (in percent) versus actual subsequent 10-year S&P 500 total returns. What’s notable is not only the strong correlation between estimated returns and actual subsequent returns, but also that the errors are informative.
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Given the full weight of the evidence, it should be clear that one can’t just say “well, look, the S&P 500 has done better than these models would have projected a decade ago,” and use that as a compelling argument that this time is different and historical regularities no longer hold. Quite the opposite – the overshoot in S&P 500 total returns since 2004 – relative to the prospective returns one would have estimated at the time – is highly informative that stocks are strenuously overvalued at present. That conclusion has strong statistical support. In fact, when we examine the historical evidence, we find that there’s a -68% correlation between the error in the projected return over the past decade and the actual subsequent total return of the S&P 500 in the following decade. That is, the more actual 10-year S&P 500 returns exceeded the return that was projected, the worse the S&P 500 generally did over the next 10 years. Notably, the “Fed Model” has a correlation of less than 48% with actual subsequent 10-year returns. It’s sad when a valuation measure that is so popular is outperformed even by the errors of better measures.
Last week, however, the market re-established conditions extreme enough to place the present instance among what I’ve often called the “who’s who of awful times to invest.” Importantly, and in contrast to a few similarly extreme conditions we’ve seen in recent years, we presently observe both widening credit spreads and – at least for now – deteriorating internals and unfavorable trend uniformity on our measures of market action.
In short, our views will shift as the evidence shifts, but here and now, the market has re-established overvalued, overbought, overbullish conditions that mirror some of the most precarious points in the historical record such as 1929, 1937, 1974, 1987, 2000 and 2007. That syndrome is now coupled with continued evidence of a subtle shift toward more risk-averse investor psychology, primarily reflected by internal dispersion and widening credit spreads. I’ve often emphasized that the worst market outcomes have historically been associated with compressed risk premiums coupled with a shift toward risk aversion among investors. In those environments, risk premiums typically don’t normalize gradually – they do so in abrupt spikes. We’ll continue to respond as the evidence changes, but under current conditions, we view the investment environment for stocks as being among a handful of the most hostile points in history.
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This time is never different.
Merely postponed...
Exactly. Rigging markets to make the game benefiting the insiders is nothing new, and will end with the same result, as in the past, a huge bust and heads on pikes.
It's a Trap!
Used judiciously, I don't think I'll ever get tired of this.
Learn to love the bomb
Yeah; i think that's a fair statement. it's a trap baited with greed. I was willing to buy B.ofA. stock at $5.00; and I did; but the stock market is sending out all kinds of signals in every direction that it's about done; like the turkey in the oven when the little red button pops out; that kind of done.
So btfath, got it
The trading desk at J.P. Morgan, and various private wealth funds in Europe will make more money faster when it crashes than they did on the way up; When the major banks decide it's time to play the short side; you'll know about it.
I used to think the same but I'm not sure anymore. This has gone on for so long now if there are nefarious elements out there waiting to pull the proverbial plug and benefit on the downside, why hasn't it happened already.
My guess is that this entire fiasco is a culmination of historic greed the likes of which the world has never seen. Sure there will be some good guesses out there of when to short and sure, they'll make enormous amounts but I am certain now that what we are seeing is the crescendo of greed as everyone tries to get their piece of the pie.
The resulting crash won't be engineered, as in, on xx/xx/xxxc at xx:xx AM/PM the market will plunge x points. The resulting crash will simply be the end of decades of millions of poeple trying to get a disproportionate share of wealth.
We are in for some major chaos. I'd also guess that when it takes hold we'll all be looking back wistfully on these crazy rigged markets as a good time in life.
Wickedly over valued..
This is the main bene. I get from Zero Hedge is being pointed to web. sites I want to study. I have Hussman's book marked now; because he has a big archive of research and real numbers; I love numbers; they lie so much less than politicians.
Now don"t forget everyone, GE is going to sell $20Billion of new stock direct to the public; Mr. and Mrs. Ignorant, themselves. Why would they do this, if they thought the market would be higher six months from now? Hmm ? Why ? Go Ahead, explain it to me; why would they ?
The chart sucks - it's very unclear. I couldn't determine the unit of measure for the y axis.
Y axis is the % return over the next 10 years. The dark green line stops 10 years ago since 10 year actual returns can't be calculated after November, 2004.
The other lines are the predicted 10 year % returns using different methodologies.
edit: those are nominal (not inflation adjusted) yearly actual and predicted returns.
A whole posse of vomiting camels!
I know...it's a Llama.....but still.
https://www.youtube.com/watch?v=A_6XHB8D9vQ
Never before was the "market" completely captured by central banks. It will all implode eventually, but this time is most certainly different.
False statement. History is very interesting. Look up John Law's work in France in around 1730; give or take a decade; I'm not going to go look it up for you; the important point being that the stock and bond market were utterly captured by the central bank; with absolutely catastrophic results. France has the distinction of utterly destroying their own currency and financial system twice in the same century; without losing a major war; or having any other valid excuse. These examples, which occured in the 1700's were very much on t he minds of Jefferson and other creators of the US Constitution, which says that only Congress shall create lawful money in the form of Gold and Silver. Most of their efforts were directed towards avoiding the nation killing exploits of various European examples they had before them; as well as making sure the Bank of England stayed in England and didn't get to play in the US. But it was imported into the US in the form of the FED. Markets reflect human mass psychology; it isn't any different. There'll be a lot of whinning and a lot of scape-goating; but there always is.
Sorry, off topic, but holy fuck! Assest forfeiture out of control. Criminal conspiracy, IMO.
http://www.nytimes.com/2014/11/10/us/police-use-department-wish-list-whe...
It IS criminal.
Don't go ANYWHERE in your car and carry a large amount of cash. If you are pulled over for ANY reason and they find it, they will immediately say it's drug money and conviscate it. Then it's up to you to prove in court what the money was for. Meantime, you don't get your money until you are vindicated in court, and you're still up for the legal costs.
Also, if you have an adult child living at home (which nearly all of us do in this 'robust' recovery), just be aware that if your kid likes to partake in the odd joint (in a state where it's not legal) and uses their phone from your house to arrange a transaction, then that is all the reason the police need to seize your house.
I have learned my lesson; why sell stocks now when I can just wait and sell later for a higher price?
1929, 1937, 1974, 1987, 2000, 2007.......
Looking at that series, one could almost see a 7 year cycle, or something like that.
Not that life was just peachy in 1981 or anything, with the recession then, and a prime rate of 21%.
Go ahead and short stocks again Charlie Brown. I promise not to pull the football away this time.
The Public Be Suckered!
The trap with this type of analysis is that right now, which is unlike any point in history, central banks are explicitly backstopping asset markets. The guys that make the rules are the biggest players the game. How does this end, I have no clue and neither does anyone else. So long as there is confidence in the central banks, the show will go on. Once that confidence is gone, that's when it's game over.
There is no lesson from history that can prepare us for what is coming. Everybody thinks they're owed something (that's what debt is), but nobody is going to get anything in the end. Promises (that's what debt is) will not be kept. There aren't enough resources on this planet to give everyone what their paper says they're entitled to. Get over it and prepare for the worst, because this paper game of "I owe you" will end when collection time rolls around. Use this time the Fed gave you to aquire assets, and by saying "assets," I am NOT referring to paper except maybe a clear title which is tied to something that is actually in your possession.
I felt a shiver up my spine reading that.
Markets don't crash while earnings are still growing. Once they stop growing, then it is time to look out below. Otherwise, as long as they are growing and central banks around the world are accomdative, it will keep going higher. Hussman is perpetually bearish and his fund returns are horrendous if you bother to look at them on morningstar.
Fuck fund returns! Who gives a shit that they are going up? Paper, ALL PAPER, will be worth jack and/or shit in the end! How stupid do you have to be to NOT get this simple fact by this late stage in the game??
So let's say he convinced you to stay out of the stock market and you went all in in Federal Bonds instead; assuming you used a little margin you would have made more money since 2009; or whatever period you're whinning aobut; and whith no heartburn; because the Bond market has been a steady up trend. It isn't anymore; but it was. The high in the thirty year long cycle of prices in the thirty year, or "Long Bond" occured in 2012; this years rally in the Long Bond was a rally in a Bear market. The Stock market is not the only market in the world; ubt it certainly provides a lot of opportunity for stress on the participants.
Don't worry - all the promises "net out." In the end, nobody really expects any actual goods or services. All they want is paper. They'll build their houses out of paper; and they'll eat, breath and shit paper. Nothing else matters. Apparently..
Within the next six months you will see that deflation is happening while, paradoxically, there will be lots of cash flowing through our Middle Class economy. There will not be a QE4 within the next Six Months to a Year.
The Stock Market will soar to new highs. Gold and Silver will tank in price. Growth will be outrageously high.
And the Main Stream Media will proclaim Janet Yellen as the saviour of the US Economy. And President Obama's popularity will soar to unseen heights. It will feel so damned good to most that all of the Doomsayers will become completely discredited.
Now many of you will attribute this to the Shale Oil Boom. Some of you will not even be able to make Heads or Tails out of the "Miraculous" turn around.
And after that rush...and that rush may last throughout 2015...the Bottom will fall away and the hollowness of that "Recovery" will be exposed. We will be in a Hyperinflationary hellhole.
The spark for the Hyperinflationary Hellhole has already happened. The Strong US Dollar Policy will serve to give the incentive for all of the World's Central Banks to divest of their Physical Cash Holdings and they will make their way to our shores and buy up everything that is not bolted down. (Why spend weak US Dollars?) That is the spark.
Furthermore the Shale Oil Boom has made it certain that the petrodollar dies. Foreign Central Banks, as a result, will not need to keep those PHYSICAL Printed $100 Bills in their vaults, ALL $12 TRILLION OF IT, any longer as Oil will be sold for other currencies. Because their currencies are so relatively weak they will spend those US Dollars, here, domestically, at a rate which will cause Monetary Velocity to spike and soar.
We will not need any QE while this is happening.
Well party hearty. It is the last hurrah, after all.
Remember these words as they will come back to haunt so many of you.
No they do not.
<”…Markets don't crash while earnings are still growing. Once they stop growing, then it is time to look out below. Otherwise, as long as they are growing and central banks around the world are accomdative, it will keep going higher…”>
Yes, and that includes “manufactured” earnings done thru stock buybacks using cheap Fed $$. It is all the same and millions all over the world have benefited by being all-in the U.S. equities markets. In essence, the Fed created $5 TRILLION of wealth to give to anyone they could draw into the markets. The upper 1% are euphoric, of course, but anybody with a 401K is thrilled too. To the Fed Bankers, they could not have been any more successful, no way. They are 100% certain if they had stayed out, it would be Great Depression times ten.
The question is, what now? Can they print to infinity if they need to? There seems to be no downside to creating money out of thin air. Deflation in nearly everything but food, and EBT cards keep the masses content. Next, the oligarchs will likely target housing. Maybe using student loan forgiveness to free up $1T for home purchases. That will send the Dow to 30K. This is all the ‘New Normal’ that the writer fails to accept. The Old Normal cannot be used to measure stock values, it no longer applies at all.
I see tech and hyper-inflated Silicon Valley real estate, leading us down big time. The Fed will throw everything they have at it and the government will increase deficit spending, etc, etc. Maybe a new bigger war too to help increase demand? There will be no ‘austerity, the entitled masses won’t stand for it. So, the bears keep getting crushed, as they can’t seem to embrace the ‘New Normal’.