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Friday, March 29, 2024

John Hussman: “Make No Mistake – This Is An Equity Bubble, And A Highly Advanced One”

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

In case someone needs a beyond idiotic op-ed on the state of the market, we urge them to read the following stunner from USA Today (which is simply a syndicated piece from the Motley Fool, complete with Batman style graphics). Beyond idiotic because in addition to quoting the perpetually amusing Stony Brook assistant professor, Noah Smith, who has never held a job outside of academia and is thus a credible source on all things markety (to wit: “The value of a financial asset is the discounted present value of its future payoffs, and when the discount rate — of which the Fed interest rate is a component — goes down, the true fundamental value of risky assets goes up mechanically and automatically. That’s rational price appreciation, not a bubble.” And by that logic under NIRP the value of an asset is… what? +??) it says this: “Stock prices correct all the time. But what’s important to remember is that a correction isn’t a bubble.” Yes, a correction is not a bubble: it is the result of one, and usually transforms into something far worse once the bubble pops.

Entertaining propaganda aside, for some actually astute observations on the state of the market bubble we go to John Hussman, someone whose opinion on such issues does matter.

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 threshholds

(as they did in 1987), the follow-through can be swift.

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