Stock Indexes Can Retrace 35-40% to Reach Historical Norms
$DIA, $SPY, $QQQ, $VXX
“Valuations are now so obscenely elevated that even an outcome that fluctuates modestly about some new, higher average would easily take the S&P 500 35 -40% lower over the completion of the current market cycle,” fund manager John Hussman said in an 8 May commentary.
The S&P 500 has risen about 12% to record highs since Republican Donald Trump won the November 8 Presidential election on a platform of cutting taxes and regulation.
The Shiller PER (price-to-earnings ratio), a measurement of how expensive stocks are in relation to company profitability, is about 29.5X, compared with a median value of 16X.
Mr. Hussman focuses on the Question of whether stocks have reached some kind of “permanently high plateau,” to paraphrase the notorious prediction by economist Irving Fisher 9 days before the stock market Crash of 1929. This time, the argument for elevated valuations rests on the notion that low interest rates and stagnant wage growth create a permanently better environment for corporate profit margins.
“The relationship between real interest rates and corporate profit margins is extremely tenuous in market cycles across history,” Mr. Hussman said. “The fact is that debt of US corporations as a ratio to revenues is more than double its historical median, leaving total interest costs, relative to corporate revenues, no lower than the post-war norm.”
Labor costs adjusted for inflation have declined in recent years, and that trend may reverse and pressure profit margins back toward historical averages.
“Though there will certainly be cyclical fluctuations, this process is likely to continue in an environment where the unemployment rate is now down to 4.4% and demographic constraints are likely to result in labor force growth averaging just 0.3% annually between now and 2024,” Mr. Hussman said. “Total employment will grow at the same rate only if the unemployment rate remains at current levels.”
The jobless rate last month fell to a 10-year low of 4.4% as U.S. companies added 211,000 workers. Labor market trends create a “dilemma for profit margins,” he said.
“If economic growth strengthens in a tightening labor market, labor costs are likely to comprise an increasing share of output value, suppressing profit margins,” he said. “If economic growth weakens, productivity is likely to slow, raising unit labor costs.”
The “China price” for goods and the “India price” for services may not suppress US wages much more.
“It’s tempting to imagine that offshoring labor would allow a sustained below-trend retreat in real unit labor costs,” Mr. Hussman said. “But while foreign labor can be cheaper, the corresponding productivity is also often lower, so the impact on unit labor costs is more nuanced than one might think.”
As corporate profit margins revert back to historical averages, stocks are more vulnerable to declines, he said.
“It has taken the third financial bubble in 17 years to bring the total return of the S&P 500 to 4.7 percent annually since the 2000 peak,” he said. “Don’t imagine that future returns will be much better from current valuations, even if future valuations maintain current levels forever. Indeed, my actual expectation is that the completion of the current market cycle will wipe out the entire total return of the S&P 500 since 2000.”
Tuesday, the major US stock market indexes finished at: DJIA -36.50 at 20975.78, NAS Comp +17.93 at 6120.57, S&P 500 -2.46 at 2396.92
Volume: Trade on the NYSE came in heavy with 1.01-B/shares exchanged
- NAS Comp +13.7% YTD
- S&P 500 +7.1% YTD
- DJIA +6.1% YTD
- Russell 2000 +2.6% YTD
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|Bullish (0.28)||Bullish (0.40)||Bullish (0.25)||Neutral (0.18)|
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