After a brief 5%-10% swoon over the past month, the stock market has popped right back to its all-time highs.
I own stocks, so that’s good news for me.
But I still think there’s a decent chance that we’ll see a major decline in stock prices over the next year or two (a 30%-50% price drop), and the recent market moves don’t change that. And I’m still very confident that stock performance from current prices will be lousy over the next 7-10 years.
I think we’ll see average returns of about 2.5% per year for the next 10 years, a far cry from the 10% long-term average.
As I’ve explained, for many reasons, I’m not selling my stocks as a result of this poor outlook. (Although if the market goes much higher, I may rethink that). I’m just not expecting to get a good long-term return from this level. And I’m keeping some powder dry, in the form of cash and bonds, which I will move into stocks if we do see a crash like the one I described above.
Stock market opinions follow the market, not vice versa. So, a month ago, when the market experienced its first meaningful decline in more than a year, the overall consensus started to become more bearish. Similarly, now that stocks have recovered, everyone’s wildly bullish again.
Be wary of that!
As Warren Buffett has observed, one of the keys to not destroying yourself in the market is to “be fearful when others are greedy, and be greedy when others are fearful.” So if the market continues to charge higher, try not to get giddy with the herd.
(At the same time, don’t be so afraid of the market that you avoid stocks altogether. If you have a long-term investment horizon — longer than 5-10 years — a significant percentage of your portfolio should almost always be invested in stocks. The risk of getting demolished by inflation over such periods is too high to try to always try to hide in bonds or cash. The market will never seem “safe.” Ever. And it will seem the least safe when it is actually the most safe — after a brutal bear market like the one we had in 2008-2009. So don’t try to time anything based on how “safe” the market seems and how “comfortable” you feel. You’ll get hosed.)
Anyway, why am I so bearish about long-term returns?
Stocks are now very expensive according to every valid long-term valuation measure that I look at. In the past, when stocks have reached these levels on these measures, they have produced lousy long-term returns. And I think the same thing will happen this time.
I’ve walked through these valuation measures in detail here. Today, I’ll just share one chart that includes them all.
This chart was produced by a fund manager named John Hussman, of the Hussman Funds.
John Hussman of the Hussman Funds is one of the most disciplined and fact-based investment managers of all those who regularly share their logic publicly. John Hussman also made a cautious (prudent) decision during the financial crisis that has hurt his investment returns ever since. As a result, most people who used to listen to John Hussman have decided that he’s an idiot and that everything he says should be ignored.
John Hussman is not an idiot. And past performance — especially recent past performance — should only rarely be used to judge whether someone is worth listening to. (Why? Because a few years of performance doesn’t tell you much about whether an investor is good or just lucky. Everyone can put together a few good years. But investment returns tend to regress to means over time. And luck always runs out.)
I, personally, don’t pay much attention to John Hussman’s recent investment performance. What I do pay attention to is John Hussman’s logic and facts.
And I find his logic and facts far more persuasive than the logic and facts of most of the whooping and effusing market bulls I see every day on TV.
So if you think I should disregard the message in the chart below, please do not tell me that John Hussman’s recent returns have been crappy. I know that. Please tell me why I should ignore the logic and facts in the chart.
In short, please tell me why “it’s different this time.”
And while you’re telling me that, please bear in mind that the phrase, “it’s different this time,” is described, with reason, as “the four most expensive words in the English language.”
Here’s the chart:
This chart compares the historical performance of seven (7) valuation measures against the actual performance of the market.
One of these valuation measures is Professor Robert Shiller’s famous “cyclically adjusted P/E ratio,” which bulls have recently put a lot of effort into trying to dismiss and debunk. But please note that the CAPE is only one of these measures. There are 6 other ones in this chart. And they all show the same thing.
The orange line in the chart is the average of these 7 valuation measures.
The blue line in the chart, which stops 10 years ago, is the actual performance of the S&P 500 in the 10 years following the date of these measures. (We don’t yet know the future 10-year performance of the market for the more recent time periods, which is why the line stops.)
So, again, what is this chart saying?
It is saying that these 7 valuation measures, all of which have shown to have been highly predictive in the past, are suggesting that future stock returns from this level will be crappy.
Could all of these valuation measures be wrong?
Yes, they could all be wrong. It could, in fact, be “different this time.” (Sometimes it is.)
But unlike some of the more bullish measures that today’s bulls sometimes throw around — such as “the Fed Model” or “price-to-adjusted-predicted-operating-earnings” — these measures have been predictive for many decades. So if the signal these measures are sending is wrong, it will have to be because “it’s different this time.”
OK, fine, but what about a crash?
Why do I think there’s a decent chance of a crash?
Because, although stocks could deliver lousy performance for the next 7-10 years by just parking at this level and calmly moving sideways, that’s generally not the way stocks behave. Generally, stocks deliver average performance by booming and busting. And, right now, you may be unnerved to learn, stocks are more expensive than they have been at any time in the past century, with the exception of a few months in 1929 and a few years around the massive bull-market peak in 1999 and 2000.
Is it possible that stocks will just keep charging higher from here, possibly for years?
Yes, again, it is possible. Anything is possible. But it doesn’t seem likely.
And, by the way, please don’t take comfort from the recent recovery from the dip of the past two months.
This behaviour is entirely consistent with the behaviour of stocks just before some major crashes.
Don’t believe it? Let’s look at some more charts. (Yes, they’re from John Hussman. Yes, I know, John Hussman’s recent returns have been crappy. Focus on the charts, please, not John Hussman or John Hussman’s recent returns).
Here’s the past ~year in our current market:
Here’s the year before the crash in 1929 (80% crash). Note the major recovery to close to the old highs just before the real crash:
Here’s the year before the 1973 crash (50% crash). Same recovery just before the real crash:
Here’s the year before the 2000 crash (50% crash). Same pattern. I remember that one, by the way. I was right in the middle of it. And I remember feeling relieved when the market recovered almost to its old highs. Then it crashed:
Yes, the market behaviour before other crashes has been modestly different. Sometimes the market sets a new high before it crashes. And, sometimes, it doesn’t crash — sometimes it just moves sideways for a long time or charges even higher.
Just please don’t delude yourself into thinking that, because the market just recovered from a “dip” or because cautious investors like John Hussman have been “wrong for years,” we’re now safe and can go hog wild.
And also don’t delude yourself into thinking that we need a “catalyst” for a crash. We don’t.