Stock market investors who gleam with visions of selling their stocks at ever higher prices should cast their eyes at a chart of the S&P 500 over the last 20 years and get out now — or they will look at that same chart in the future and ask themselves “What was I thinking?”
So warns Hussman Funds portfolio manager John Hussman in his most recent letter to shareholders, his latest in a years-long series of warnings about the risk of stock market valuations, which he now characterizes in perhaps his most emphatic terms yet:
“Prospective returns have reached zero. The value you seek from selling in the future is already on the table today. The future is now.”
The portfolio manager known for his bearish views but also for some prescient market calls writes that some of the “saddest notes” he received in the 2000-2002 and 2007-2009 bear markets came from investors lamenting “I wish I had listened.”
The losses of those bear markets wiped out the total S&P 500 gains all the way back to May 1996 in the former case and even further, to June 1995, in the more recent crash.
To convey a bit of how that feels, Hussman quotes a 2001 warning he issued conservatively estimating price targets for Cisco at $18 ¾ (when its 52-week high was $82), Sun Microsystems at $4 ½ (when its 52-week high was $64), EMC at $10 (when its 52-week high was $105) and Oracle at $6 ⅞ (when its 52-week high was $46).
With the ensuing crash, three of those stocks fell 50% below these price targets, and one of them hovered near the target price.
But the overvaluation of that period — and here’s the core of Hussman’s current warning — pales in comparison to current market conditions.
“The median price/revenue multiple for S&P 500 constituents is now significantly higher than at the 2000 market peak,” Hussman writes.
Only by looking at market-cap weighted price/revenue multiples can one find two quarters where valuations were higher in 2000, but Hussman recalls that the market at that time favored megacap stocks, which skewed the “average” versus “median” yardstick. (Though even viewed in terms of a cap-weighted ratio, he says the historical norm is less than half current levels.)
The Hussman Funds manager focuses his analysis on price to revenue rather than price to earnings because of the unreliability of profit margin assumptions embedded in the former. But he argues that one has to view current record-high profit margins as permanent, “against all historical experience,” to see current valuations as anything other than historically extreme.
That means that anything short of a seven-year time horizon implies negative total returns; a 10-year time horizon carries an expectation of “weak total returns;” and Hussman warns passive buy-and-hold investors that a 50-year horizon is needed to justify such a strategy.
The academic-turned-manager known for his data-driven approach offers something of an apology, or encouragement to hang on, to Hussman fund investors who have missed the large gains in recent years during which his funds have followed a risk-off approach.
“Though we fully anticipated the 2008 credit crisis and had no qualms about valuation after the market plunged,” the imperative of “stress-testing against Depression-era outcomes … prevented us from accepting opportunities in the recent half-cycle.”
But that “miss,” he adds, “should not be a reason for investors to ignore the objective risks over the completion of this cycle – from what is now the richest broad market valuation that investors are likely to observe in their lifetimes.”
The doomsaying portfolio manager hits an upbeat note in anticipation of a time when his portfolio need not be defensively oriented, saying “we remain enormously optimistic about investment opportunities that are likely to emerge over the completion of the present market cycle and beyond.”