An Expensive Market
PARIS – Yesterday, we reported that the U.S. manufacturing sector shrank for the fifth month in a row in December. We could have added that it is now back to levels last seen in July 2009 – in the immediate aftermath of the global financial crisis.
Image via elitewm.com
We could have mentioned, too, that the Baltic Dry Index – which tracks the cost of shipping raw materials by sea – just hit a record low. We’ve been citing many other fundamental indicators all pointing the same way – toward a weakening global economy.
The BDI (Baltic Dry Index, an index of international dry bulk shipping rates) has suffered a collapse of 96% since its 2008 peak – with that it is the only serious competitor still in contention for the “greatest crash in history” title, which is currently held by the stock market of Cyprus – click to enlarge.
Why, then, are stocks – which are supposed to look ahead – still telling us that the coast is clear?
The Dow fell about 2% last year. And the S&P 500 fell by just under 1%. Neither was enough to cause alarm. And after a rough start on Monday, the mainstream press reports that prices “stabilized” yesterday.
But according to Nobel prize-winning economist Robert Shiller, U.S. stocks have almost never been so expensive. His cyclically adjusted price-earnings ratio – or CAPE ratio – looks at the relationship between share prices and the average inflation-adjusted earnings from the previous 10 years.
This controls for – or “smoothes” – year-to-year swings in corporate earnings, which can be highly volatile. As a result, Shiller says, it gives a more accurate picture of what kind of value is on offer.
Right now, the CAPE ratio for the S&P 500 is 25.5. Only three times in the last 135 years has it been higher – in 1929, 2000, and 2007. None of these turned out to be a good time to add to your stock account.
The CAPE ratio (a.k.a. P/E-10, or Shiller-P/E ratio) is at an extremely high level.
But wait… The story is a little more complicated. The Dow and the S&P 500 have been buoyed up by the performance of a few companies that have done very well.
The tech-heavy Nasdaq, too, owes its positive numbers to the so-called FANG stocks – Facebook, Amazon, Netflix, and Google (now called Alphabet).
These four tech darlings have been running wild – reminding us of the dot-com craze of the late 1990s. And all (bar Alphabet) trade at price-to-earnings ratios of more than 100. But if you look beyond the major indexes, you don’t see stocks running wild… you see them running for cover.
A “Stealth” Bear Market
In fact, it looks as though a “stealth” bear market has already begun. For example, the median stock in the Russell 3000 – a broad measure of the U.S. stock market – has fallen 20% since hitting its 52-week high.
That should ring some bells. A 20% fall from a 52-week high is a standard definition of a bear market. What is going on? Dr. John Hussman of Hussman Funds speaks for us:
“I remain convinced that the U.S. financial markets, particularly equities and low-grade debt, are in a late-stage top formation of the third speculative bubble in 15 years.
On the basis of the valuation measures most strongly correlated with subsequent market returns (and that have fully retained that correlation even across recent market cycles), current extremes imply 40-55% market losses over the completion of the current market cycle, with zero nominal and negative real total returns for the S&P 500 on a 10-to-12-year horizon. These are not worst-case scenarios, but run-of-the-mill expectations.”
In terms of Dr. Hussman’s proprietary stock market valuation measures, the current market is actually the second most overvalued ever. Only the year 2000 mania peak still towers above it – though not in terms of the ratio of non-financial debt to gross value added (in red), as this measure has reached a new record high. Read, US listed companies are up to their eyebrows in debt. The measure in blue has been chosen on the basis of extensive back-testing (the ratio of non-financial market cap to national non-financial gross value added incl. foreign revenues). According to Dr. Hussman, this valuation measure is the by far best predictor of subsequent 12 year returns – click to enlarge.
Now we will speak for ourselves: We recall that in 2000 – the same year we suggested shifting out of U.S. stocks – Warren Buffett looked ahead. And he saw a “Lost Decade” coming for the U.S. stock market.
Stock prices had gotten so high relative to GDP that he reckoned it was unlikely that we would see a positive return over the next 10 years. He was right. Stocks went up until 2007… and then crashed down again, ending the decade lower than where they began it. Investors lost money. And now? Hussman continues:
“The risk cycle has already turned, and the familiar canaries in the coalmine – market internals and credit spreads – have been deteriorating persistently, in the same way that deteriorating internals and sub-prime defaults were the first warning signs to emerge in 2007… the consequences of years of distorted capital flows and yield-seeking are already unfolding.”
Our proprietary stock market indicator, based on research by former ValueLine analyst Stephen Jones, shows much the same thing: losses for U.S. stock market investors as far as the eye can see. Unless, that is, you can see further than 10 years ahead.
Until then, our indicator predicts lower U.S. stock prices, as the equity market adjusts to high current prices, over-regulation, a crushing debt load, misallocation of resources, and aging populations. Will Jones and Hussman be right? Will we be right? Who knows?
Here you can see the inverted chart of the market cap/gross value added chart (blue) with the subsequent 12-year annual S&P 500 return overlaid in red. Hand and glove come to mind.
But if you check your broker statement in 2025… and find you have only half as much real wealth as you have today… remember: We warned you. If, on the other hand, you’ve made a lot of money by ignoring us… please forget we said anything.
Charts by: StockCharts, John Hussman, Bonner & Partners
Image captions by PT
The above article originally appeared at the Diary of a Rogue Economist, written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.
Dear Readers! We are happy to report that we have reached our turn-of-the-year funding goal and want to extend a special thank you to all of you who have chipped in. We are very grateful for your support! As a general remark, according to usually well informed circles, exercising the donation button in between funding drives is definitely legal and highly appreciated as well.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
Most read in the last 20 days:
- Alan “Bubbles” Greenspan Returns to Gold
Faking It Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. […] The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. — Alan Greenspan, 1961 He was in it for the power and the glory... Alan Greenspan gets presidential bling...
- The Gold Situation
A Growing Bullish Chorus – With Somewhat Muted Enthusiasm A few days ago a well-known mainstream investment house (which shall remain nameless) informed the world that it now expects the gold price to reach “$1,500 by early 2017”. Our first thought was: “Now they tell us!”. You won't be surprised to learn that the same house not too long ago had its eyes firmly fixed in the opposite direction. Da bling be goin' somewhere, fellow rastas and homies! Photo via...
- End of an Era: The Rise and Fall of the Petrodollar System
The Transition “The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros. The sooner the better.” Ron Paul A new oil pipeline is built in the Saudi desert... this one is apparently destined for the Ghawar oil field, one of the oldest fields in Saudi Arabia...
- European Banks and Europe's Never-Ending Crisis
Landfall of a “Told You So” Moment... Late last year and early this year, we wrote extensively about the problems we thought were coming down the pike for European banks. Very little attention was paid to the topic at the time, but we felt it was a typical example of a “gray swan” - a problem everybody knows about on some level, but naively thinks won't erupt if only it is studiously ignored. This actually worked for a while, but as Clouseau would say: “Not...
- Writing on the Wall
Time to Sell... Maybe BALTIMORE – Yesterday, the S&P 500 hit a new all-time high. And the Dow just hit a new record close as well. If you haven’t sold yet, dear reader, this may be one of the best times ever to do so. It's still flying... sorta. Meet Bill Bonner's tattered crash flag Image credit: fmh We welcome new readers with a simple insight: Markets are contrary, pernicious, and downright untrustworthy. Just when the mob begins to bawl most loudly...
- Gold – Eerie Pattern Repetition Revisited
Gold Continues to Mimic the 1970s Ask and ye shall receive... we promised we would update the comparison chart we last showed in late November in an article that kind of insinuated that it might be a good time to buy gold and gold stocks (see: “Gold and Gold Stocks – It Gets Even More Interesting” for the details). We are hereby delivering on that promise. A Lydian gold stater from the time of the famously rich King Croesus, approx. 570 BC. It seems they already had this...
- Fat People for Trump!
Alphas and Epsilons BALTIMORE – One of the delights of being an American is that it is so easy to feel superior to your fellow countrymen. All you have to do is stand up straight and smile. Or if you really need an ego boost, just go to a local supermarket. Better yet, go to a supermarket with a Trump poster in the parking lot. The protest vote attractor with the funny hair. Image credit: Liberty Maniacs Trigger warning: In the following ramble, we make fun of...
- Destination Mars
Asset Price Levitation One of the more preposterous deeds of modern central banking involves creating digital monetary credits from nothing and then using the faux money to purchase stocks. If you’re unfamiliar with this erudite form of monetary policy this may sound rather fantastical. But, in certain economies, this is now standard operating procedure. The “Tokyo Whale” Haruhiko Kuroda explains his asset purchase madness with a few neat little slides. Photo credit:...
- America Has Become a “Parasitocracy”
Dread and Denial So, let’s return to the discussion you can’t have with your congressman, your mailman, or your barmaid. It’s the important one. It concerns what the Fed is really up to. Eight years after achieving independence, a State modeled after the British merchant state was established in the US. It took a while for the Deep State to consolidate itself within it, a process that was accelerated greatly in the run-up to and aftermath of WW I. Illustration by Ana...
- The Central Planning Virus Mutates
Chopper Pilot Descends on Nippon Readers are probably aware of recent events in Japan, the global laboratory for interventionist experiments. The theories of assorted fiscal and monetary cranks have been implemented in spades for more than a quarter of a century in the country, to appropriately catastrophic effect. Amid stubbornly stagnating economic output, Japan has amassed a debt pile so vast since the bursting of its 1980s asset bubble, it beggars the imagination. A...
- Planet Debt
Low Interest Rate Persons She is a low-interest-rate person. She has always been a low-interest-rate person. And I must be honest. I am a low-interest-rate person. If we raise interest rates, and if the dollar starts getting too strong, we’re going to have some very major problems. — Donald Trump Two low interest rate persons! The Trumpsumptive president (Donald the Tremendous) can be seen here indicating the approximate size of the interest rate that will...
- Long Term Market Perspectives
Methuselah Tree When looking for a good theme for this post I pondered for a while and then decided to use a picture of a bristlecone pine, which are widely considered to be the oldest living trees in the world. Ye olde bristlecone Photo credit: Kosta Konstantinidis You can find them near the Nevada/California border and if you wind up traveling in the area then I strongly recommend that head over to Bishop and from there head up high up into the White...