John Hussman: "Make No Mistake - This Is An Equity Bubble, And A Highly Advanced One"

From Zero Hedge

 

Selected excerpts from: Yes, This Is An Equity Bubble

Make no mistake – this is an equity bubble, and a highly advanced one. On the most historically reliable measures, it is easily beyond 1972 and 1987, beyond 1929 and 2007, and is now within about 15% of the 2000 extreme. The main difference between the current episode and that of 2000 is that the 2000 bubble was strikingly obvious in technology, whereas the present one is diffused across all sectors in a way that makes valuations for most stocks actually worse than in 2000. The median price/revenue ratio of S&P 500 components is already far above the 2000 level, and the average across S&P 500 components is nearly the same as in 2000. The extent of this bubble is also partially obscured by record high profit margins that make P/E ratios on single-year measures seem less extreme (though the forward operating P/E of the S&P 500 is already beyond its 2007 peak even without accounting for margins).

Recall also that the ratio of nonfinancial market capitalization to GDP is presently about 1.35, versus a pre-bubble historical norm of about 0.55 and an extreme at the 2000 peak of 1.54. This measure is better correlated with actual subsequent market returns than nearly any alternative, as Warren Buffett also observed in a 2001 Fortune interview. So if one wishes to use the 2000 bubble peak as an objective, we suggest that it would take another 15% market advance to match that highest valuation extreme in history – a point that was predictably followed by a decade of negative returns for the S&P 500, averaging a nominal total return, including dividends, of just 3.7% annually in the more than 14 years since that peak, and even then only because valuations have again approached those previous bubble extremes. The blue line on the chart below shows market cap / GDP on an inverted left (log) scale, the red line shows the actual subsequent 10-year annual nominal total return of the S&P 500.

All of that said, the simple fact is that the
primary driver of the market here is not valuation, or even fundamentals, but perception. The perception is that somehow the Federal Reserve has the power to keep the stock market in suspended and
even diagonally advancing animation, and that zero interest rates offer “no choice” but to hold equities
.

Be careful here. What’s actually true is that the Fed has now created $4 trillion of idle currency and bank reserves that must be held by someone, and because investors perceive risky assets as having no risk, they have been willing to hold them in search of any near-term return greater than zero. What is actually true is that even an additional year of zero interest rates beyond present expectations would only be worth a roughly 4% bump to market valuations. Given the current perceptions
of investors, the Federal Reserve can certainly postpone the collapse of this bubble, but only by making the eventual outcome that much worse.

Remember how these things unwound after 1929 (even
before the add-on policy mistakes that created the Depression), 1972, 1987, 2000 and 2007---- all market peaks that uniquely shared the same extreme overvalued, overbought, overbullish syndromes that have been
sustained even longer in the present half-cycle. These speculative episodes don't unwind slowly once risk perceptions change.

The shift in risk perceptions is often accompanied by deteriorating market internals and widening credit spreads slightly before the major indices are in full retreat, but not always. Sometimes the shift comes in response to an unexpected shock, and other times for no apparent reason
at all. Ultimately though, investors treat risky assets as risky assets. At that point, investors become increasingly eager to hold truly risk-free securities regardless of their yield. That’s when the music stops. At that point, there is suddenly no bidder left for risky and overvalued securities anywhere near prevailing levels.

History suggests that when that moment comes, the
first losses come quickly. Many trend-followers who promised themselves to sell on the “break” suddenly can’t imagine selling the market 10-20% below its high, especially after a long bull market where every dip was a buying opportunity. This is why many investors who think they can get out actually don’t get out. Still, some do sell, and when those trend-following sell signals occur at widely-followed thresholds (as they did in 1987), the follow-through can be swift.

http://www.zerohedge.com/news/2014-07-27/john-hussman-make-no-mistake-equity-bubble-and-highly-advanced-one

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