Market valuations, on these measures, presently approach or exceed the 1929 and 2000 extremes, placing U.S. equity market valuations at the most offensive levels in history.
Indeed, with median valuations on these measures now more than 2.7 times their historical norms, there is strong reason to expect a market loss on the order of -63% over the completion of the current market cycle; a decline that would not even bring valuations below their historical norms (which we’ve typically seen by the completion of nearly every market cycle outside of the 2002 low).
"...unlike the 2000 valuation extreme, which was largely focused on a subset of extremely overvalued technology stocks, the current market extreme is the broadest episode of extreme equity market overvaluation in history. The chart below shows the median price/revenue ratio of S&P 500 component stocks, which set yet another record high in the week ended November 3, 2017, and now stands more than 50% above the 2000 extreme."
The following chart below shows our Margin-Adjusted CAPE as of November 3, 2017.
On this measure, market valuations are now more extreme than at any point in history, including the 1929 and 2000 market highs.
Finally Hussman reminds the complacent majority of how this well end:
The final chart is a reminder of how these speculative episodes end.
In 2000, most deciles experienced losses on the order of 30-50%, with the exception of the hypervalued top decile represented, at the time, by technology stocks.
In March 2000, I wrote: “Over time, price/revenue ratios come back in line. Currently, that would require an 83% plunge in tech stocks (recall the 1969-70 tech massacre). If you understand values and market history, you know we’re not joking.”
While it feels like it at the moment, trees can't grow to the sky, but as Hussman concludes, it’s clear from market internals that investors again have the speculative bit in their teeth.
What’s important, however, is to distinguish near-term speculative outcomes from longer-term investment outcomes.
If history is any guide, the first leg down from the current speculative blowoff is likely to be abrupt and rather vertical. Investors will be tempted to buy into that decline, and may very well be rewarded for it over the shorter-run. The problem is that while investors are reluctant to sell into strength here, they may also have no tolerance for selling into a market loss once internals break down. Instead, they will likely pass up their opportunity to reduce exposure to market losses even after market internals deteriorate clearly.
After that, the intermittent hope from fast, furious (but ultimately failing) rallies will likely encourage them to hold on all the way into a deep market collapse. That’s how severe market declines unfold.