February 2013
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John P. Hussman “S&P 500 Index Overvalued”

Wall Street analysis has been bearish on Wall Street since 2009. The DJIA recently hit 14,000 again, the first time since 2007 but this is a “nominal” number that does not take into inflation. Inflation adjusted the DJIA is still 9.4% below it’s 2007 high.

For those not familiar the Federal Reserve “pumps” money int the stock market to keep “liquidity” and “markets moving” in a upward direction. Some would call this money creation a EBT card for the top 0.01%.

Towards the end of 2010 the Federal Reserve announced it would be creating $600 billion known as “Quantitative Easing part II” and distributing the money through the federal open market committee (FOMC) to member banks such as Goldman Sachs and JP Morgan (the owners of the private Federal Reserve) which in turn can invest in equities.

In this graph of the DJIA the upward positive affect can be seen for the duration of the program up to about the end of June 2011. After the program ended you can see the drop in the stock market. The stock market and bond market has been receiving these injections of cash and are now overpriced and dependent on the Federal Reserve polices of inflating the money supply.

Despite this discount Hussman is still bearish on stocks and bonds. The only reason equities have been performing the last four years have been the massive Federal Reserve interventions in the marketplace called by various names notably quantitative easing and operation twist.

Here is what Hussman had to say about the value investors can expect to see in the near future:

In recent years, I’ve gained the reputation of a “perma-bear.” The reality is that I’m quite a reluctant bear, in that I would greatly prefer market conditions and prospective returns to be different from what they are. There’s no question that conditions and evidence will change, unless the stock market is to be bound for the next decade in what would ultimately be a low-single-digit horserace with near-zero interest rates. For my part, I think the likely shocks are larger, and the potential opportunities will be greater than investors seem to contemplate here. Investors who are eager to lock in whatever prospective return might be available at present valuations – or have operationalized their investment discipline and tested its outcomes across market cycles over history – can certainly ignore the evidence that drives my own concerns. Even then, I expect that the perspectives here would augment the performance of that discipline. But for investors who have tested no discipline at all, and have little data to support the enthusiasm that surrounds them, what follows is a summary of my concerns.

Present market conditions now match 6 other instances in history: August 1929 (followed by the 85% market decline of the Great Depression), November 1972 (followed by a market plunge in excess of 50%), August 1987 (followed by a market crash in excess of 30%), March 2000 (followed by a market plunge in excess of 50%), May 2007 (followed by a market plunge in excess of 50%), and January 2011 (followed by a market decline limited to just under 20% as a result of central bank intervention). These conditions represent a syndrome of overvalued, overbought, overbullish, rising yield conditions that has emerged near the most significant market peaks – and preceded the most severe market declines – in history:

John P. Hussman’s graph “I can’t stress enough the importance of seeing the larger picture here – it would have been easy to miss the forest and get lost in the weeds and trees of daily and weekly market advances at each point identified in the chart above. Pursuing short-term returns in those environments would have been a mistake, because the initial losses typically came in the form of vertical “air pockets.””

S&P 500 Index overvalued, with the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) greater than 18. The present multiple is actually 22.6.
S&P 500 Index overbought, with the index more than 7% above its 52-week smoothing, at least 50% above its 4-year low, and within 3% of its upper Bollinger bands (2 standard deviations above the 20-period moving average) at daily, weekly, and monthly resolutions. Presently, the S&P 500 is either at or slightly through each of those bands.

Investor sentiment overbullish (Investors Intelligence), with the 2-week average of advisory bulls greater than 52% and bearishness below 28%. The most recent weekly figures were 54.3% vs. 22.3%. The sentiment figures we use for 1929 are imputed using the extent and volatility of prior market movements, which explains a significant amount of variation in investor sentiment over time.

Yields rising, with the 10-year Treasury yield higher than 6 months earlier.

The blue bars in the chart below identify historical points since 1970 corresponding to these conditions.”

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