MAR 6, 2018
Between outright Fed buying and keeping interest rates at near zero, the central bank has both directly and indirectly thrown money at the stock market, giving less sophisticated and patient investors feeling like they have nowhere else to invest to earn decent returns. The full extent of this temporary scaffolding will only become apparent when it collapses
I continue to expect the S&P 500 to lose about two-thirds of its value over the completion of the current market cycle. With market internals now unfavorable, following the most offensive “overvalued, overbought, overbullish” combination of market conditions on record, our market outlook has shifted to hard-negative.
The most reliable measures of valuation we identify are now between 2.6 and 3.0 times their pre-bubble historical norms. No market cycle in history, not even in recent decades, has ended without bringing those measures within 20-40% of those norms (and usually below them).
This implies that even a run-of-the-mill completion to the present market cycle can be expected to take the S&P 500 between 45% and 65% lower, even without breaking below historical valuation norms. Likewise, I fully expect that even after dividends, the total return of the S&P 500 over the coming 12-year period will be negative.
With valuations that, on our most reliable measures, ranged between 2.6 and 3.0 times their historical norms at the recent market high, normalizing valuations over a 10-year horizon implies a drag on the order of -9.1% to -10.4% below what equities would be expected to return at normal valuations.
Indeed, even normalization over a 20-year horizon implies a drag on the order of -4.7% to -5.3% annually below what equities would be expected to return at normal valuations.