'I’ll emphasize again that the worst market outcomes in history have typically unfolded when extreme overvalued, overbought, overbullish conditions have been joined by deteriorating market internals and upward pressure on credit spreads and risk-premiums. Conversely, the strongest market outcomes in history have typically unfolded when a substantial retreat in market valuations has been joined by early improvement in those measures of market action..''Late last year, we adapted our methods to prioritize the condition of market internals ahead of those “overvalued, overbought, overbullish” warning signs,
with no exceptions. Sufficiently extreme market conditions can still encourage us to take a neutral outlook, but in all cases, zero interest rates or not, market internals have to deteriorate explicitly in order for us to adopt or amplify a negative market outlook.
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The single most reliable valuation measure we’ve ever tested or introduced is the ratio of nonfinancial market capitalization to corporate gross-value added (including estimated foreign revenues). Last week, that measure pushed back into the top 0.5% of all historical observations, to a level exceeded only by the 2000 market peak and the recent February 2018 market peak. Our margin-adjusted CAPE has just slightly lower reliability, but benefits from a much longer data history. The margin-adjusted CAPE substantially improves the reliability of Robert Shiller’s cyclically-adjusted P/E by adjusting for variations in the profit margin embedded into the earnings figure.
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Frankly, the behavior is reminiscent of the 2007 peak, just before the global financial crisis, when I wrote “It’s already clear that low risk premiums are being pressed decisively higher. Market breadth has deteriorated. Leadership has also reversed decisively. I’ve noted over the years that substantial market declines are often preceded by a combination of internal dispersion, where the market simultaneously registers a relatively large number of new highs and new lows among individual stocks, and a leadership reversal, where the statistics shift from a majority of new highs to a majority of new lows within a small number of trading sessions.”
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It’s worth emphasizing that the message here is not “sell everything.” Rather, investors should carefully evaluate their risk tolerance, their investment horizon, their sensitivity to market losses, and their tolerance for regret (both the regret of missed market gains as a result of being defensive, and the regret of suffering market losses as a result of being constructive). In my view, investors should seriously consider the prospect of a market decline on the order of -65% from the recent market highs, and their capacity to tolerate that sort of loss without abandoning their investment discipline. Investors with limited investment horizons should also consider the likelihood, suggested by current valuation extremes, that total market returns over the coming 10-12 years may be negative even if they maintain their discipline through a steep interim market loss.
I’ll emphasize again that the worst market outcomes in history have typically unfolded when extreme overvalued, overbought, overbullish conditions have been joined by deteriorating market internals and upward pressure on credit spreads and risk-premiums. Conversely, the strongest market outcomes in history have typically unfolded when a substantial retreat in market valuations has been joined by early improvement in those measures of market action. If our measures of market internals improve, we will defer the immediacy of our downside concerns. Here and now, my impression is that complacency could prove to be a costly instinct.'
- John P. Hussman, Ph.D.,
Mind the Trap Door, June 27, 2018
'It was A Decisive Quarter: The world became more divided; the "Atlantic Alliance" became more divided; Europe became more divided; Asia became more divided; North America became more divided; and the United States turned only more divided..''The U.S. currency and equities market were beneficiaries of the rapidly deteriorating global backdrop. This market dynamic stoked the booming American economy. I would argue there is a clear downside to bubbling U.S. markets and economic output: For one, the environment emboldens both the Fed and President Trump. The Powell Fed is emboldened to follow through with rate and balance sheet normalization. The President, meanwhile, is emboldened to push through with his aggressive trade and political agendas - prominently with plans for major tariffs and additional tax cuts.
Booming markets ensure imaginations run wild. Importantly, reality began to gain the upper hand during the quarter. The global Bubble faltered. The world is not robust - there are, indeed, fragilities everywhere. EM is a potential disaster. China is increasingly vulnerable. China and Asian debt has become a huge global risk. I worry about Brazil.
And this age of populism and the "strongman" politician actually does matter to the markets. Trump Tariffs. China ready to "punch back." Erdogan to dictate Turkish rate policy? The new Italian government to play hardball with the EU. Immigration becoming a pressing political issue from Washington to Frankfurt. A new leftist President in neighboring Mexico. Well, booming markets were content to disregard the global rise of populism, divisiveness and autocracy. Faltering markets will now amplify these troubling trends. All the makings for savage bear markets.
It was A Decisive Quarter: The world became more divided; the "Atlantic Alliance" became more divided; Europe became more divided; Asia became more divided; North America became more divided; and the United States turned only more divided. U.S. stock performance during the quarter should not distract from the ominous storm clouds forming globally - in the markets, economically, socially and geopolitically. Global markets were also more divided, though I would expect Contagion from the Periphery to now make more discernable headway toward the Core.'
- Doug Noland,
A Decisive Quarter, June 30, 2018
'In describing the global debt train wreck these last few weeks, I’ve discovered a common problem. Many of us define “debt” way too narrowly.
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So, take whatever estimates are made about future deficits and debt, and realize they are going to be worse. There will be fewer people working and paying taxes and more people living longer and using benefits. Kiss your assumptions goodbye.
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Next week, I will try to close this series by summing up all the debt we have to deal with globally, recognizing that we are all in it together.'
- John Mauldin,
Unfunded Promises, June 29, 2018
Context '..the mainstream failure to recognize the dynamic elements of an economy..''..assets Bubbles, replete with history's greatest redistribution of wealth.''..a decade-long debt .. emerging markets..' - '..a tech bubble larger than March of 2000..'Hallmark of an Economic Ponzi Scheme'..to not be an endless source of easy credit and bail-outs..'