John Hussman puts the smackdown on the "Stocks are cheap here" thesis so popular amongst certain types of analysts:
"Overvalued, overbought, and overbullish conditions have generally
resulted in disappointing market returns, regardless of other features
of market action. Yet the past several weeks have quietly added a new
ingredient: Treasury bill yields are now higher than they were 6 months
ago, and Treasury yields of all maturities have popped higher in recent
weeks. While this might seem like a trivial and low-magnitude event, it
actually contributes to a syndrome that has invariably been negative
for near-term market outcomes (not to mention the negative long-term
results that overvalued market conditions have historically produced).
As of last week, the Market Climate for stocks was characterized by unfavorable valuations, moderately favorable market action, and a combination of overvalued, overbought, overbullish conditions that has historically been associated with short-term returns below Treasury bill yields. As noted above, even the modest upward pressure on Treasury yields in recent weeks has made the present risks far more pointed…"
Of course, the key is how we define these measures — that will certainly determine how often these elements all line up. Hussman defines them as follows:
Overvalued: S&P 500 price/peak earnings greater than 18
Overbought: S&P 500 at a 4-year high, and at least 5% higher than its level 6 months earlier
Overbullish: Investors Intelligence percentage of bullish advisors above 53%
Yield pressure: 3-month Treasury yield higher than its level of 6 months earlier
None of those metrics are particularly extreme — its the concurrent combination that presents an increasing risk factor.
Surprsingly, prior to the most recent example (November 17, 2006, December 8, 2006 and January 12, 2007), there have only been 8 previous periods when these elements all lined up together:
April 30, 1965
December 18, 1972 / January 5, 1973
August 14/21 1987
April 3, 1998
April 23, 1999
July 2/16, 1999
December 23/31 1999
March 24, 2000
Here’s what they look like on a long term chart:
Chart courtesy of Hussman Funds
The market performance subsequent to this signal are detailed at Hussman’s site.
John P. Hussman, Ph.D.
January 15, 2007
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