An Impressive Rebound, but Hollow Inside
In his recent weekly market update, John Hussman once again discusses his main bearish argument, namely the combination of market overvaluation and deteriorating internals. He rightly (in our opinion) regards the latter as a signal indicating a shift in risk appetites. Here are two quotes from the article summarizing the essential points:
“Valuations are the primary driver of long-term returns, and the risk-preferences of investors — as conveyed by the uniformity or divergence of market action across a broad range of individual stocks, industries, sectors and security types (including credit) — drive returns over shorter portions of the market cycle.”
[…]
“The combination of extreme valuations on historically reliable measures, the deterioration of market internals following an extended period of overvalued, overbought, overbullish conditions, and the weakening of leading economic measures, particularly on measures of new orders and order backlogs, has clear precedents historically, and those precedents are uniformly bad.”
Image via aufinia.com
We would add to this that while it is true that the precedents with similar combinations of factors are uniformly bad, there are always different lead times involved before cap-weighted indexes actually peak. These moves toward the eventual top can have blow-off-like characteristics, such as in 1929 (when stocks like RCA and other “story stocks” of the time rose to a frantic peak while the larger list of stocks was already weakening), 1973 (the “nifty fifty” era) or more recently, the year 2000 blow-off in technology stocks. The latter event was highly unusual in terms of size and speed, but it shows what can happen.
However, even if we assume that in today’s case the lead time will be larger than usual (and a blow-off will happen and thus be of a size that will be greater than average), it would only tell us – again based on historical precedent – that the subsequent losses will be all the more devastating (e.g., what happened subsequently to the year 2000 blow-off was a more than 80% decline in the Nasdaq; the 1929 blow-off in the DJIA was followed by a 90% wipe-out). Unless that is, if central banks decide to go “Zimbabwe” on us (we don’t assume that they will, but if they did, one could probably sell a big position in, say, NFLX for $10,000/share one day, and to paraphrase Kyle Bass “buy three eggs with the proceeds”).
Currently, the cap-weighted indexes as well as the Dow Jones Industrial Average are in fact already supported by blow-off like rallies in several of the stocks that have the biggest influence on the indexes either due to their capitalization weighting or their price weighting (GOOG, AMZN, MCD, etc.).
Below is a chart illustrating the situation in terms of the very broad NYSE Index (NYA), which conveys a much better picture of how the average diversified portfolio is doing (it has made no progress in quite some time) than the more popular indexes or averages. Included is the percentage of NYSE listed stocks above their 200 and 50 day moving averages. The latter measure has almost re-entered “short term overbought” territory, but only 35.9% of all stocks included in the NYA are actually above their 200 dma. It seems to be a bull market in which most stocks are actually in a bear market.
