US Stocks—Overstretched….Again

Once again, the S&P500 marched upward, and once again, on declining volume. This week, the S&P rose by almost 0.7%. And volatility dipped slightly—slightly only because it had already dropped by quite a bit over the previous two weeks.

Amid this incredible boomerang in US stocks, the US economic reports mostly disappointed. PMI manufacturing, for example, missed expectations. Construction spending collapsed, when it was instead expected to rise. International trade missed badly. ISM services also disappointed. For the week, only ISM manufacturing and factory orders beat expectations, and even then, only slightly. The big number of the week—payrolls—missed. Fewer jobs were created than experts had predicted. And average hourly earnings rose by half the amount expected. Meanwhile, the labor force participation rate remains stuck at multi-decade lows….which means that the US labor markets are still a disaster.

So after going into a mini free-fall in October, US stocks boomeranged right back to where they started—at former record highs and actually a bit beyond.

So now, stock prices sit right back where they started in late September, at extremely overstretched levels….once again. And as history shows, over and over again, when prices are so severely overstretched, bad things tend to happen, as they did in mid October, when prices went into a short-term free-fall.

This begs the question—is another sell-off similar sell-off about to hit US stock markets? And the answer is that they are once again extremely vulnerable to another sell-off, but that this severely overstretched condition does not guarantee that they will sell off in the short run.

What the extreme overvaluation does guarantee however, as John Hussman so clearly points out in his newsletters, is that anyone who buys or owns stocks at these prices should expect to realize a future return—-from today’s prices—-that is far below historical stock returns.

Why? The logic (and the historical data supporting it) is quite simple—if you pay a super high price for stocks now, you should expect a super low return over your future holding period.

This simple, yet very easy to forget, principle has never failed to work over the entire history of US stock prices….a span of time that exceeds 100 years.

What makes it easy to forget is that almost all investors seem to forget the lessons of history…..usually as the stock markets make,and continue to make, new highs. Most everyone begins to believe that “this time is different”, when in the end, when a market cycle finally completes itself (by the way, we are currently only in the first half of the cycle—the bull market that started after the bear market lows were reached in 2009), it’s never different.

This market has another cycle ahead of it. Eventually, the bear market that always follows the bull market will begin. And only after this bear market ends, can investors finally determine if they’ve made money—by measuring gains and losses over a complete, bull and bear, market cycle.


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