'In August 2007, shortly before the global financial crisis unfolded, I observed that strong economic optimism is a contrary indicator..''Still, be careful about what you do with information about valuations. If overvaluation was sufficient to halt a market advance, we would never have observed valuations like 1929, 2000, and today, because those advances would have ended at lesser extremes. It’s common to imagine that if valuations have pushed to extreme levels without a collapse, there must be something wrong with the valuation measures. But that’s not how valuations work.
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..What was required, and the way we ultimately adapted, was to refrain from adopting negative market outlook – regardless of how extreme “overvalued, overbought, overbullish” conditions became – until our measures of market internals deteriorated explicitly.
That deterioration occurred most recently on February 2nd of this year. Our measures of market internals remain unfavorable here, largely because of narrowing leadership, divergent market action among individual stocks, and weakness in corporate bonds. It’s important to emphasize that improvement in our measures of market internals would shift our immediate market outlook to a neutral and possibly even constructive view (with a strong safety net), regardless of valuations that I view as obscene. At this point in the cycle, it should be no surprise that we insist on a safety net in any event, but even that will change as market conditions do.
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We always have to allow for the possibility that market internals could improve, indicating that investors had taken an indiscriminate speculative bit in their teeth again. Favorable internals would encourage us to adopt a more neutral or constructive (with a safety net) near-term outlook. But faced with the same conditions we observe at present, investors have historically found nothing but trouble.
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In my view, investors are grasping at straws if they are relying on the Fed to prevent the damage from an increasingly likely market collapse. Not that the Fed won’t try, but remember that the effect of Fed actions on market outcomes, like the impact of valuations, is entirely dependent on the psychological inclination of investors toward speculation or risk-aversion. That’s why the information we extract from the uniformity or divergence of market internals is so important to our market outlook.
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In August 2007, shortly before the global financial crisis unfolded, I observed that strong economic optimism is a contrary indicator:
“Despite credit concerns, Wall Street remains exuberant about economic prospects. Last week brought a 6-year high in consumer confidence, evidently supporting the idea that the consumer remains strong and the economic expansion remains intact. Unfortunately, if you examine the data, you’ll quickly discover that consumer confidence is a lagging indicator, well explained by past movements in GDP, employment, and capacity utilization. Worse, for the stock market, it’s a contrary indicator (especially when it is well above the “future expectations” component of the same survey). This is a fact that I’ve noted at both extremes, not only in early 2000 when new highs in consumer confidence supported a defensive position, but conversely in the early 1990’s, when new lows in consumer confidence supported a leveraged position in stocks (prompting that ‘lonely raging bull’ comment in the L.A. Times). High levels of economic optimism are regularly observed at the peaks of both U.S. and foreign economic expansions. This includes the general consensus of individuals, businesses, politicians, central bank officials and notoriously – economists. That shouldn’t be surprising. It’s the very nature of a peak that it can’t be produced except by unusual optimism.”
Last week, consumer confidence pressed to a fresh cyclical high. As Tavi Costa at Crescat Capital observed, similar extremes in consumer confidence have regularly preceded substantial market losses. If market internals were favorable here, indicating a continued inclination of investors to speculate, I would view the extremes in confidence, valuations, sentiment, and price action with a much more neutral eye. But until investor psychology shifts away from risk aversion, as evidenced by uniform market internals, the market remains vulnerable to severe losses.
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Current stock market capitalization is largely an artifact of speculative psychology, not reasonably discounted cash flows. Unless investors rely on eternal sunshine of the spotless mind – the assumption that current levels of extreme cyclical optimism will be permanent – they should not expect the associated valuation extremes to be permanent either. Very deep market losses are likely, even in the absence of a recession.
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Again, given current valuation extremes in stocks, unfavorable market internals, and a relatively flat yield curve in bonds, I believe that lowly, humble cash has substantial option value, because it offers the opportunity to respond to potentially deep market losses. The strongest estimated market return/risk prospects emerge when a material retreat in valuations is joined by an early improvement in our measures of market action.'
- John P. Hussman, Ph.D.,
Eternal Sunshine of the Spotless Mind, September 4, 2018
Context'..the Bubble .. it is decidedly global .. So long as confidence holds at the "core" and speculation runs unabated..''..the long-run negative effects of debt eventually outweigh their short-term positive effects..''..this extends to corporate bonds, equities and real estate prices. It is a global ‘everything bubble’.''..each bursting Bubble is to be reflated by a more formidable Bubble inflation.''Eurozone countries face massive amounts of debt coming due in the 2018–2020 period..''..China's historic mortgage finance and apartment Bubbles maintain powerful momentum..''..an escalation of the unfolding EM crisis..''After decades of overuse, debt is increasingly less productive in all of these areas..'Our Obsession with Consumption — while Ignoring Saving and Investment — Is a Big Problem