Bubble Mindset

The comments above & below is an edited and abridged synopsis of an article by John Hussman, Ph.D

“So the mindset, I think, goes something like this. Yes, market valuations are elevated, but, you know, low interest rates justify higher valuations. Besides, there’s really no alternative to stocks because you’ll get what, 1% annually in cash? Look at how the market has done in recent years. There’s no comparison. Value investors who thought stocks were overpriced in recent years have been wrong, wrong, and wrong again, and even if they’re eventually right, being early is just the same as being wrong. The best bet is just to invest in a passive index fund for the long-term, and ignore the swings. There’s really no alternative.”

This mindset is the essence of a bubble mentality. It boils down to the proposition that stocks have gone up, and though valuations have become rich, stocks have continued to go up, so valuations must not matter that much. Stocks are viewed as good investments because they have been going up, and the evidence that stock prices will go up is that stock prices have gone up. Every additional market advance makes stocks look even better, based on past returns. Indeed, the more extreme valuations become, the more convinced investors become that extreme valuations don’t matter… “and that’s why we’re all gonna die,” says Hussman.

Hussman discusses a few insights that may help to deconstruct this mindset, including a study of 5, 10 and 20-year growth rates in population, labour force, productivity, S&P 500 revenues, earnings, real GDP, nominal GDP, and other measures of fundamentals.

In conclusion he says: “I fully expect the completion of the current market cycle to wipe out the entire total return of the S&P 500, in excess of Treasury bill returns, all the way back to 2000, and more likely to roughly October 1997 (and that’s assuming that valuations don’t even breach historical norms). We’ve certainly drawn useful lessons from the recent half-cycle, but whether the market moves higher or lower in the near term, I doubt that value-conscious investors will lament having been ‘too early’ by the time this cycle is completed.”