But don't imagine for a moment that
current valuation extremes will end in something other than tragedy unless investors shift back from risk - aversion to a fresh round of speculation (which we would infer from market internals).
It's both dangerous and needless to dismiss
current valuation extremes.
This would not be a worst - case scenario, but only a run - of - the - mill cycle completion from the standpoint of
current valuation extremes.
However, the overall market return / risk climate could become consistent with a more neutral or modestly constructive outlook (with an obligatory safety net in either case, given
current valuation extremes) if market internals were to improve decisively.
If those factors were positive here, our concerns about immediate downside risks would be less pointed, regardless of
current valuation extremes.
Not exact matches
Even the 4 % annual total return of the S&P 500 in the 15 years since the 2000 peak has been made possible only by driving
current valuations to the second most
extreme point in U.S. history.
To expect normal or above - average long - term returns from
current prices is to rely on the market bailing out the rich overvaluation of today with
extreme bubble
valuations down the road.
Given the increasingly steep slope of the
current market advance, along with the most
extreme valuations in history and the most lopsided bullish sentiment in more than three decades, it's quite possible that this instance will be different.
The right - tail risk is the possibility that the
current bullish environment has more horsepower and stamina than we're forecasting, which could push
valuations to even greater
extremes.
Rather, a Crash Warning means that
current market conditions (
extreme valuations, poor trend uniformity, hostile yield trends) match only about 4 % of history, yet every crash of note has emerged from this one set of conditions.
The main points here are that QE has encouraged the dramatic overvaluation of virtually every class of investments; that these elevated
valuations don't represent «wealth» (which is embodied in the future stream of deliverable cash flows, not in the
current price); that
extreme valuations promise dismal future outcomes for investors over a 10 - 12 year horizon; and that until a clear improvement in market internals conveys a resumption of speculative risk - seeking by investors, the
current combination of
extreme valuations and increasing risk - aversion, coming off of an extended top formation after persistent «overvalued, overbought, overbullish»
extremes, represents the singularly most negative return / risk classification we identify.
While the marginal production cost issue undoubtedly makes the
current extreme in the gold / XAU ratio less compelling than it might appear otherwise, we do believe that precious metals shares are quite depressed in
valuation terms.
Among the
valuation measures having the strongest correlation with actual subsequent market returns,
current levels are actually within 10 % of the March 2000
extreme.
Our own concern about elevated profit margins is not that earnings will be weak over the completion of the
current cycle (though that increasingly appears likely), but that investors are using historically
extreme profit margins and record earnings as if they are completely representative of decades and decades of future earnings, and are using those earnings figures as a sufficient statistic for
valuation.
The S&P 500 registered a record high after an advancing half - cycle since 2009 that is historically long - in - the - tooth and already exceeds the
valuation peaks set at every cyclical
extreme in history but 2000 on the S&P 500 (across all stocks,
current median price / earnings, price / revenue and enterprise value / EBITDA multiples already exceed the 2000
extreme).
Back in October, I noted «investors clearly are approaching the
current market with every belief that the
extreme valuations of 2007 represent the sustainable norm to which stocks should return.
With the exception of the 2000
extreme, every secular bull market has died before reaching even the
current level of
valuations.
A month ago, I noted that prevailing
valuation extremes implied negative total returns for the S&P 500 on 10 - 12 year horizon, and losses on the order of two - thirds of the market's value over the completion of the
current market cycle.
In Table 3, of the 96 tests for factors, only 2 have the «wrong» sign, with higher
valuation pointing to (negligibly) higher subsequent returns; both instances of the «wrong» sign are in the emerging markets, for which we have shorter history, and are for the low beta factor, for which the
current valuations, in the 99th percentile, are quite
extreme relative to history.
While the marginal production cost issue undoubtedly makes the
current extreme in the gold / XAU ratio less compelling than it might appear otherwise, we do believe that precious metals shares are quite depressed in
valuation terms.
This is where the market's
current valuation provides significant insight, particularly when those
valuation measures reach historical
extremes.
The famed money manager sounded the alarm that the
current housing «
valuation extreme» looks a lot like it is 2005 all over.