John Hussman’s report this week, Estimating Market Losses at a Speculative Extreme, has an interesting chart on Median price-to revenue ratios over time. Let’s dive in.
I added the dashed blue line for ease in comparison to the dot-com bubble peak. Here are some snips from Hussman.
“One of the things that you may have noticed is that our downside targets for the market don’t simply slide up in parallel with the market. Most analysts have an ingrained ‘15% correction’ mentality, such that no matter how high prices advance, the probable maximum downside risk is just 15% or so (and that would be considered bad). Factually speaking, however, that’s not the way it works… The inconvenient fact is that valuation ultimately matters. That has led to the rather peculiar risk projections that have appeared in this letter in recent months. Trend uniformity helps to postpone that reality, but in the end, there it is… Over time, price/revenue ratios come back into line. Currently, that would require an 83% plunge in tech stocks (recall the 1969-70 tech massacre). The plunge may be muted to about 65% given several years of revenue growth. If you understand values and market history, you know we’re not joking.”
That’s not from today. It’s what Hussman wrote on March 7, 2000.
Hussman notes “The S&P 500 followed by losing half of its value by October 2002, while the tech-heavy Nasdaq 100 lost an oddly precise 83%.”
In regards to today, and of the chart posted above, Hussman has this to say, emphasis his:
The distinction between today and the 2000 peak is in the breadth of overvaluation across individual stocks. Back in 2000, the most extreme speculation was centered on a fraction of all stocks, largely representing technology, and accounting for a large proportion of the total market capitalization of the S&P 500 Index.
At the March 2000 bubble peak, an understanding of market history (including the outcomes of prior speculative episodes) enabled my seemingly preposterous but accurate estimate that large-cap technology stocks faced potential losses of approximately -83% over the completion of the market cycle.
At the 2007 market peak, by contrast, stocks were generally overvalued enough to indicate prospective losses of about -55% for all but the very lowest price/revenue decile. That risk was realized in the form of widespread and indiscriminate losses across all sectors during the market collapse that followed, even though financial stocks were hardest hit.
In my view (supported by a century of market cycles across history), investors are vastly underestimating the prospects for market losses over the completion of this cycle, are overestimating the availability of “safe” stocks or sectors that might avoid the damage, and are overestimating both the likelihood and the need for some recognizable “catalyst” to emerge before severe market losses unfold. We presently estimate median losses of about -63% in S&P 500 component stocks over the completion of the current market cycle. There is not a single decile of stocks for which we expect market losses of less than about -54% over the completion of the current market cycle, and we estimate that the richest deciles could lose about -67% to -69% of their market capitalization. As in 2000 and 2007, investors are mistaking a wildly reckless world for a permanently changed one, and their re-education in the concept that valuations matter is likely to be predictably brutal.
Placing the Blame
Hussman accurately places the blame on central banks as well as investors who believe the central bank is in control.
Central banks possess no concealed, mysterious knowledge that is somehow obscure to mortals. If anything, one might question whether some FOMC governors have ever carefully examined historical data at all, given that many of their propositions can be refuted by even the most basic scatterplot
One thing should be clear: policy makers have not become “smarter.” What they have become, with each bubble-crash cycle, is more reckless and arrogant in their willingness to extend speculative financial conditions by encouraging yield-seeking, compressing prospective future investment returns, amplifying the destructive consequences that inevitably result, and ironically, using those same consequences to justify fresh intervention.
Hussman admitted his errors, as have I. Neither of us anticipated:
- The jaw-dropping lengths of central bank recklessness in this half-cycle
- The ability of yield-seeking speculation to defer the implications of even the most extreme “overvalued, overbought, overbullish” conditions
- The importance of prioritizing the uniformity of market internals in a zero-interest rate environment
Investors have the same choice today as they have had at every point in time over the past few years.
Sorry guys, FOMO and the TINA excuse (there is no alternative) do not work.
Meanwhile, those who embraced the bubble are mocking those who didn’t. That is a contrarian warning. Alan Greenspan provides another.
Be very concerned when Greenspan spots bubbles that do not exist while touting those that don’t.
Mike “Mish” Shedlock