"The Most Extreme Point Of Stock Market Overvaluation In History"

Tyler Durden's picture

Excerpted from John Hussman's Weekly Comment,

The atmosphere is getting thin up here, and every ounce counts triple when you're climbing in rarefied air. While near-term market dynamics are more likely to be impacted by Friday’s employment report than any other factor, our broad view remains that stocks are in the late-stage top formation of the second most extreme episode of equity market overvaluation in U.S. history, second only to the 2000 peak, and already beyond the 1929, 1937, 1972, and 2007 episodes, not to mention lesser extremes across history.

On the economic front, much of the uncertainty about the current state of the economy can be resolved by distinguishing between leading indicators (such as new orders and order backlogs) and lagging indicators (such as employment). It’s not clear whether the weakness we’ve observed for some time in leading indicators will make its way to the employment figures in time to derail a Fed rate hike in December, but as we’ve demonstrated before, the market response to both overvaluation and Fed actions is highly dependent on the state of market internals at the time. Presently, we observe significant divergence and internal deterioration on that front. If we were to observe shift back to uniformly favorable internals and narrowing credit spreads, our immediate concerns would ease significantly, even if longer-term risks would remain.

Having reviewed the divergences we observe across leading economic indicators and market internals last week (see Dispersion Dynamics), a few additional notes on current valuations may be useful.

As I’ve noted before, the valuation measures that have the strongest and most reliable correlation with actual subsequent market returns across history are those that mute the impact of cyclical variations in profit margins. If one examines the deviation of various valuation measures from their historical norms, those deviations are rarely eliminated within a span of a year or two, but are regularly eliminated within 10-12 years (the autocorrelation profile drops to zero at that point). As a result, even the best valuation measures have little relationship to near-term returns, but provide strong information about subsequent market returns on a 10-12 year horizon. Among the most reliable valuation measures we identify, those with the strongest relationship with subsequent 12-year nominal S&P 500 total returns are:

  • Shiller P/E: -84.7% correlation with actual subsequent 12-year S&P 500 total returns
  • Tobin’s Q: -84.6% correlation
  • Nonfinancial market capitalization/GDP: -87.6%
  • Margin-adjusted forward operating P/E (see my 8/20/10 weekly comment): -90.7%
  • Margin-adjusted CAPE (see my 5/05/14 weekly comment): -90.7%
  • Nonfinancial market capitalization/GVA (see my 5/18/15 weekly comment): -91.9%

MarketCap/GVA is presented below to provide a variety of perspectives on current valuation extremes. The chart below shows this measure since 1947. We know by the relationship between MarketCap/GVA and other measures (with records preceding the Depression) that the current level of overvaluation would easily exceed those of 1929 and 1937, making the present the most extreme point of stock market overvaluation in history with the exception of 2000. In hindsight, the only portion of 2000 when stocks were still in a bull market was during the first quarter of that year.

To be as clear as possible: Over the near term, broad improvement in market internals and credit spreads would suggest a return to risk-seeking speculation that might defer the unwinding of this obscene Fed-induced speculative bubble, or could even extend it. But with market internals presently negative and credit spreads continuing to widen, the market remains vulnerable to an air-pocket, panic or crash, here and now. In either case, our expectation is that the completion of the current market cycle will involve a market loss of at least 40-55%; a loss that would merely take the most historically reliable valuation measures to run-of-the-mill pre-bubble norms, not materially below them.

Investors should remember from the 2000-2002 and 2007-2009 collapses that in the absence of investor risk-seeking - as conveyed by market internals - even aggressive Fed easing does not support stocks. The reason is that once investors become risk-averse, safe, low-interest liquidity is a desirable asset rather than an inferior one. So creating more liquidity fails to achieve what the Fed does so successfully and perniciously during a risk-seeking bubble: drive investors to chase yield and speculate in risk-assets.

The chart above places MarketCap/GVA on an inverted log scale (blue line, left scale), along with the actual S&P 500 nominal annual total return over the following 12-year period (red line, right scale). Note that current valuations imply a 12-year total return of only about 1% annually. Given that all of this return is likely to come from dividends, current valuations also support the expectation that the S&P 500 Index will be lower 12 years from now than it is today. While that outcome may seem preposterous, recall that the same outcome was also realized in the 12-year period following the 2000 peak.

Given both obscene valuations and clearly unfavorable market internals and credit spreads at present, we see extreme market losses as not only an immediate risk, but also as the predominant likelihood over the next few years.

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Save_America1st's picture

"...and every ounce counts triple"...


That's almost like the Comex slogan:

"Where every ounce counts 300!"  (paper, of course)  ;-)

Arnold's picture


Advice for maintaining patience.



Advice for maintaining patents.



Advice for maintaining patients.



More for your money, an advanced English lesson as well.

Dr. Venkman's picture

we see extreme market losses as not only an immediate risk, but also as the predominant likelihood over the next few years


Maybe, but not today.

Slimjimmy's picture
Slimjimmy (not verified) Dr. Venkman Dec 1, 2015 4:33 PM

Like most here, I once believed that the FED has complete control over markets. I don't anymore. Here's why:


If the FED had complete control, and assumedly didn't want crises(which I don't personally assume), then why do we have them? I don't accept the lame "we screwed up"excuse.


For those who are familiar with Wave Theory, you know its incredibly accurate at predicting long term moves. How can this be if the FED determines market direction? This goes for Fibonacci as well.


The FED often says, "we don't have as much control as people think we do."

I used to think they were trying to deny their manipulation with this statement. Now I see they're actually telling the truth, but are well aware that practically nobody believes them. This may play into a reverse psychology strategy they use, in their goal of convincing the market they are in complete control.



RAT005's picture

Fed manipulation isn't price setting.  It's loss containment so the Banksters dare go farther out on a limb. Then the Fed's fellow gov. Scum celebrate market value as validation of their achievements until the correction and then blame someone else. 

Demdere's picture

Gee, you mean things might change?

Like the economy doesn't generate taxes, and the gov can't borrow any more?  But surely we have that covered, it would be such an obvious thing to avoid!


I don't see much of the inevitable priced into our market.  Taleb-style investors are having happy holidays, I think. Betting against government optimism is such a certain thing that it is rarely this profitable.


Rainman's picture

Market losses when ? ..... get back to us after the Draghi bazooka goes off.


margincall575's picture
margincall575 (not verified) Dec 1, 2015 4:03 PM

correction. The most extreme "manipulation" in history

Hongcha's picture

Yes; and it is about to get extreme-er.  That SPY chart looks set to blast off to higher-er highs than ever.

Keep incrementing into short positions.  You will continue to lose.  It's 4 a.m. and the harsh light of dawn will soon enough be upon us ... but someone found another keg in the garage so here we go.  not saying it's right, just imvho.

LawsofPhysics's picture

Define "value"...

priced in what exactly?  almost 8+ billion souls all competing for the resources required for a higher standard of living and fewer and fewer with access to the printing press...

The world has been here before...  ...although the weapons technology has gotten a bit better...

...interesting times...

wcvarones's picture

What are the 10-year forward returns on bonds when the 10-year Treasury is at 2.2%?

What are the 10-year forward returns on cash when CDs are yielding 0.5%?

vesna's picture

next few years? wtf

venturen's picture

there is no market....just a place to put printed paper

assistedliving's picture

will someone tell Hussman to stop making sense please...

allamerican's picture

listen some clown today say sp sitting at 16 cash, i thought 15 (nuts with current condition).  then clown says sp should go 17 1/2 cash on mrkt turn.

if QE happens it can accordingly, then what?? the sp sitting at 2400 and nothing resolved.  cycle turn witch hunt thats what.............

Thisisbullishright's picture

Oh not today Bishop, not today...



Raymond_K._Hessel's picture
Raymond_K._Hessel (not verified) Dec 1, 2015 4:37 PM

So the unprecedented printing of wholly unbacked fiat can be correlated without confound to pre nixon shock etc etc?

Well i guess some basics apply - with massive unprecedented printing mostly helicoptered to banks who can make billions by taking their fedmoney and just buying us debt.. And with most people in debt and nearly maxed out, tons of money, more than ever, went into stocks.

Right or no?

2007/2008 was largely about CDOs/bonds/tranching which hid but did not destroy risk.


And in terms of metrics there was and is no law requiring bond funds to report honest WAM.

Using interest rate reset dates AS maturity dates probably helped killed funds at bear stearns and in fact, the correlation between true wam and hedge fund implosion was as tight as Taylor Swift's snizz.

Presumably bond funds learned their lesson?


LawsofPhysics's picture

China might want to weigh in on your comment about 2008/2009...

MBS?  If only we could get a complete audit of the Fed...

devo's picture

Collecting nickles in front of a bulldozer.

conraddobler's picture

So you're saying there was one time where it was worse than this?


I say we double up on 2000 and really draw a chart that is impressive.