Hussman Weekly Market Comment: Short Horizon, Long Horizon

Over history, and including the past decade, properly normalized valuations have remained a powerful guidepost for full-cycle and long-term returns, particularly on the horizon of 7-10 years. On that front, the current price/revenue multiple of the S&P 500 of 1.54 is now nearly double the historical norm prior to the late-1990’s bubble. The same is true for other useful metrics such as the market value of nonfinancial stocks to nominal GDP (based on Z.1 flow of funds data). With our broadest estimate of prospective S&P 500 10-year nominal total returns down to just 2.9% annually, 10-year Treasury bond yields at 2.7%, Treasury bill yields pinned at zero, and state and corporate pension assumptions still in the range of 7-8% annually, it appears quite likely that the coming decade will produce a widespread pension funding crisis in the U.S.

Meanwhile, the current Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) of 24.2 is closer to 65% above its pre-bubble median. Despite the 10-year averaging, Shiller earnings – the denominator of the Shiller P/E – are currently 6.4% of S&P 500 revenues, compared to a pre-bubble norm of only about 5.4%. So contrary to the assertion that Shiller earnings are somehow understated due to the brief plunge in earnings during the credit crisis, the opposite is actually true. If anything, Shiller earnings have benefited from recently elevated margins, and the Shiller P/E presently understates the extent of market overvaluation. On historically normal profit margins, the Shiller P/E would be about 29 here. In any event, on the basis of valuation measures that are actually well-correlated with subsequent market returns, current valuations are now at or beyond the most extreme points in a century of market history, save for the final approach to the 2000 peak.

Of course, valuations exert far more effect on long-term returns than on short-term outcomes, where a much larger set of considerations generally apply. Unfortunately, on shorter horizons, the past few years have been unusual. Market conditions that have historically resulted in awful losses over the intermediate-term have instead been associated with positive returns.