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.
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
Most read in the last 20 days:
- Ganging Up on Gold
So Far a Normal Correction In last week's update on the gold sector, we mentioned that there was a lot of negative sentiment detectable on an anecdotal basis. From a positioning perspective only the commitments of traders still appeared a bit stretched though, while from a technical perspective we felt that a pullback to the 200-day moving average in both gold and gold stocks shouldn't be regarded as anything but a normal - and in this case actually long overdue -...
- Gold Sector Correction – Where Do Things Stand?
Sentiment and Positioning When we last discussed the gold sector correction (which had only just begun at the time), we mentioned we would update sentiment and positioning data on occasion. For a while, not much changed in these indicators, but as one would expect, last week's sharp sell-off did in fact move the needle a bit. Gold - just as nice to look at as it always is, but slightly cheaper since last week. Photo via The Times Of India The commitments of...
- Australian property bubble on a scale like no other
Australian property bubble on a scale like no other Yesterday Citi produced a new index which pinned the Australian property bubble at 16 year highs: Bubble trouble. Whether we label them bubbles, the Australian economy has experienced a series of developments that potentially could have the economy lurching from boom to bust and back. In recent years these have included: the record run up in commodity prices and subsequent correction; the associated...
- Pope Francis: Traitor to Western Civilization
Disqualified There has been no greater advocate of mass Muslim migration into Europe than the purported head of the Catholic Church, Pope Francis. At a recent conference, he urged that “asylum seekers” be accepted, “through the acts of mercy that promote their integration into the European context and beyond.”* Before we let Antonius continue with his refreshingly politically incorrect disquisition, we want to remind readers of two previous articles that have...
- Bubble Dissection
The Long Term Outlook for the Asset Bubble Due to strong internals, John Hussman has given the stock market rally since the February low the benefit of the doubt for a while. Lately he has returned to issuing warnings about the market's potential to deliver a big negative surprise once it runs out of greater fools. In his weekly market missive published on Monday (entitled “Sizing Up the Bubble” - we highly recommend reading it), he presents inter alia the following eye-popping...
- A Looming Banking Crisis – Is a Perfect Storm About to Hit?
Andy Duncan Interviews Claudio Grass Andy Duncan of FinLingo.com has interviewed our friend Claudio Grass, managing director of Global Gold in Switzerland. Below is a transcript excerpting the main parts of the first section of the interview on the problems in the European banking system and what measures might be taken if push were to come to shove. Andy Duncan of FinLingo.com (left) and Claudio Grass of Global Gold (right) Andy Duncan: How do you see the...
- US Stock Market - a Spanking May be on its Way
Iffy Looking Charts The stock market has held up quite well this year in the face of numerous developments that are usually regarded as negative (from declining earnings, to the Brexit, to a US presidential election that leaves a lot to be desired, to put it mildly). Of course, the market is never driven by the news – it is exactly the other way around. It is the market that actually writes the news. It may finally be time for a spanking though. Time for some old-fashioned...
- Doomed to Failure
Larded Up and Larded Over We’ve been waiting for the U.S. economy to reach escape velocity for the last six years. What we mean is we’ve been waiting for the economy to finally become self-stimulating and no longer require monetary or fiscal stimulus to keep it from stalling out. Unfortunately, this may not be possible the way things are going. As Milton Jones once revealed: “A month before he died, my grandfather covered his back in lard. After that, he went...
- Are the Deep State’s Drones Coming for You?
What’s Aleppo? Look out kid Don’t matter what you did Walk on your tip toes Don’t try "No Doz" Better stay away from those That carry around a fire hose Keep a clean nose Watch the plain clothes You don’t need a weather man To know which way the wind blows – “Subterranean Homesick Blues,” Bob Dylan The entrance to Baghdad's “Green Zone”. Photo credit: Karim Kadim / AP DELRAY BEACH, Florida – Biggest foreign policy blunder...
- Meet Your New Stimulus Allocation Czar
March Towards Midnight The march towards midnight is both stirring and foreboding. Like a death row inmate sitting down to savor his last meal, a grim excitement greets the reality of impending doom. Thoughts of imminent mortality haunt each bite. Tic-toc, tic-toc... As far as the economy’s concerned, there’s no stopping its march towards midnight. The witching hour’s rapidly approaching. We intend to savor each moment and make the best of...
- Interview with Doug Casey
Natalie Vein of BFI speaks with Doug Casey Our friend Natalie Vein recently had the opportunity to conduct an extensive interview with Doug Casey for BFI, the parent company of Global Gold. Based on his decades-long experience in investing and his many travels, he shares his views on the state of the world economy, his outlook on critical political developments in the US and in Europe, as well as his investment insights and his approach to gold, as part of a viable strategy for...
- Evacuate or Die...
Escaping the Hurricane BALTIMORE – Last week, we got a peek at the End of the World. As Hurricane Matthew approached the coast of Florida, a panic set in. Gas stations ran out of fuel. Stores ran out of food. Banks ran out of cash. A satellite image of hurricane Matthew taken on October 4. He didn't look very friendly. Image via twitter.com “Evacuate or die,” we were told. Not wanting to do either, we rented a car and drove to Maryland. “We’ll just...