In one of his great Monday morning missives, John Hussman discusses "The Anatomy of a Bubble". The bottom line is that regardless of what the economy does, when stock valuations are reasonable, investors can expect reasonably satisfactory investment returns. Yes, regardless of what the economy does. On the other hand, stocks that reflect high valuations will greet investors with very disappointing returns over the subsequent 5-10 years. If there is one cardinal rule to investing, it's that your future returns will depend upon the valuation of what you purchase. One would think that two massive stock market bubbles in the past 12 years would have taught investors that, but one would be wrong. Here's the key chart from Hussman:
Presently, the Shiller P/E stands at 24. Be careful how you interpret the data in the table for Shiller P/E's above 24, since these levels were almost never observed in data prior to the late-1990's market bubble...
Indeed, outside of the bubble period since the late 1990's, the only historical instance of Shiller P/Es materially above 24 was between August and early-October of 1929. The closest we got to 24 in post-war data was in mid-1965. While prices went on to achieve moderately higher levels (lagging earnings growth, so that the Shiller multiple fell), the mid-1965 valuation peak is widely viewed as the starting point for a 17-year "secular" bear market during which the S&P 500 achieved total returns of less than 5% annually through 1982, despite severe inflation. That's a good reminder that stocks are not a very good inflation hedge during periods when inflation is rising, particularly when stock valuations are already elevated and are priced to achieve poor returns. Stocks only "benefit" from inflation during hyperinflations and during sustained and anticipated inflations. In other cases, the eventual adjustments in economic activity and valuations overwhelm the "beneficial" effect of inflation on earnings.
As Hussman further emphasizes, these returns are for the next 5 & 10 year periods and says nothing of what can happen in the short-term. We have a madman at the monetary wheel and a bunch of drunk Congressmen in the back seat. Who knows how long this ride can go before someone "jerks the wheel into a god*&m bridge abutment" (what movie, anyone?).
To further emphasize how poorly stocks perform over the long-term when P/E's are as high as they are now, Mike Shedlock provides the following chart:
So here we sit, with a Shiller P/E of 24. Stocks are priced for absolute perfection. History says returns going forward will be very disappointing. I don't know about you, but a world with massive budget deficits, exploding debt, money-printing central banks, revolutions in the Middle East and North Africa, and nuclear issues in Japan doesn't strike me as one I'd like to take a chance on that "perfect" outcome.
In addition, remember that pension plans in the U.S. are underfunded by multiple trillions, and most of them assume annual returns in the 8% range just to even have that funding deficit. With the 10-year Treasuries at mid-3% range, the expectation is that stocks need a 12.5% annual return to make up the difference. The odds of that are slim to none, IMHO.
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