It’s mid-May, and if you haven’t taken the opportunity to “Sell in May and Stay Away” you still have some time. Since I penned last month’s piece, we’ve seen a slew of advisors, columnists, and retired asset managers chime in with their own warnings, some of them dire, and all of them based on sound analysis and a firm grasp of market history. Don’t take my word for it; consider the following:
Writing at seekingalpha.com, Beverly Hills advisor Craig Brockie writes that “A new bear market has begun. Volatility bottoming last year was the first warning signal. More recently we’ve seen the Russell 2000 run out of steam, corporate insiders selling and the general public buying in droves. On top of this, stocks are more overvalued today than they were at the peak in 2007…”
Adam Hamilton, a CPA and contrarian analyst, points out “as of this year, stocks are more overpriced than they were prior the 2008 financial crisis.” Further, he argues that while the average price-to-earnings ratio for the largest 500 companies in the United States has been around 14 for nearly 125 years, “prior to the 2008 financial crisis, these same stocks reached peak price to earnings ratios of 23.1. As of the end of March of this year, the average price-to-earnings ratio for those 500 stocks was 25.7. This indicates that even if corporate profits were to remain constant, stock prices would need to drop 45% just to reach their historical average of 14.” (emphasis added)
A 45% drop in the S&P 500? The numbers don’t lie, and the history of “reversion to the mean” tells us that whenever we spend an extended period well above historic rates of return, the tendency of markets is to overshoot on the downside as well, spending roughly an equal number of months or years below those historic averages. Famed asset manager John Hussman of the Hussman Funds agrees, saying “our estimates for probable S&P 500 nominal total returns have now declined below zero on every horizon of 7 years and shorter.” He adds that, “Everything that investors can expect to obtain from selling stocks 7 years from now is already on the table today” (his emphasis), and that “our projection for 10-year S&P 500 nominal total returns peeks its head up above zero, at about 2.4% annually from current levels.” Not mincing words, Hussman concludes, “Investors are now making the broadest and most leveraged bet on overvalued equities in U.S. history.”
What makes forecasts like these even direr, says Brockie, is that while corporate insiders (officers, directors, etc.) have recently been selling their shares, the general public (the least knowledgeable investors) “have been borrowing more money to buy stocks than they ever have. As always, knowledgeable insiders, commercial traders and contrarian investors are unloading their positions near the current all-time highs to an unsuspecting public that really should know better by now—especially after what happened in 2000 and 2007.”
Michael O’Rourke, chief market strategist at Jones Trading, adds a bit of macabre humor to the conversation, likening today’s investors to zombies: “Gone is the rising tide of 2013 that fueled big gains for most equities. The low-quality positive catalysts and growing negative catalysts have us starting to wonder if this market is dead and it just doesn’t know it yet.” O’Rourke sees a big problem for this market, pointing out that “market leadership has been driven by a defensive rotation, with investors buying because they don’t want to be left out of the market, not because they like what’s on offer.” Similar observations were made by the likes of Alan Greenspan in 1998 when the dot.com bubble was inflating amid the “irrational exuberance” of that period.
Finally, there’s recently retired former chairman of Goldman Sachs Asset Management, Jim O’Neill whose former job as a brokerage-employed economist was to attract capital to that firm. Now that he can be less biased—i.e. more honest—he gave some decidedly lukewarm answers when questioned about his confidence in U.S. markets by MarketWatch reporter Sara Sjölin:
MarketWatch: “If you had money to invest now, would you put any of it in the U.S. stock market?”
O’Neill: “Not really. No.”
As we’ve been saying for months now, the remaining upside of this market may not be worth the downside risk ahead and, given what’s already in the rear view mirror, investors could look back on this moment in a year or two wishing they’d taken heed of such warnings.
Thomas K. Brueckner
President & Chief Executive Officer