April 22, 2024
According to multiple experts, we’re in a bubble.
One is portfolio manager Diego Parrilla, who wrote “The Anti-Bubbles: Opportunities Heading into Lehman Squared and Gold’s Perfect Storm.” His book describes bubbles as the process by which asset valuations become artificially inflated and anti-bubbles as the process by which assets become artificially deflated.
Simply put, assets are expensive in a bubble and cheap in an anti-bubble. Parilla says anti-bubbles are a tool for investors to defend against bubbles.
Veteran “bubble watcher” Jeremy Grantham of asset manager GMO recently pointed out how the S&P 500’s current valuation is in the top 1.0% of its history as measured by the Shiller price-earnings ratio or the cyclically adjusted P/E ratio (also called the CAPE ratio). It’s over 34 today, and if this is the top of the market, it’s the third most expensive peak in U.S. stock market history. The CAPE ratio was only higher in December 1999 and November 2021.
The prospects for good returns from these peaks have been poor in the past. The only bull markets that continued from levels like this where the last 18 months in Japan until 1989 and the U.S. technology bubble of 1998-99. We know how poorly those ended.
Another known “bubble watcher,” economist and portfolio manager John Hussman, thinks we should mind history. He said current market conditions have a stronger positive correlation with historical market peaks and a stronger negative correlation with historical market lows than in 99.9% of recorded instances. According to Hussman, the market is in the top 0.1% of historical market peaks and 10 times more expensive compared with history.
So, Grantham showed sustained rallies have never happened from moments like this in the past and Hussman said the market now negatively correlates with 99.9% of all historical market lows. Grantham’s data goes back to 1871, while Hussman’s dates to 1928, so these aren’t new-found fads.
Thus, history shows that expecting big (or any) returns from stocks at times like these has been a losing proposition over time. If that doesn’t induce skepticism of today’s market, I suspect nothing will. In the next post, we’ll cover what to do about it.