Monday, October 19, 2009

The Stock Market Has Never Been This (Intermediate-Term) Overbought

October 19, 2009

The Stock Market Has Never Been This (Intermediate-Term) Overbought

John P. Hussman, Ph.D.
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If you spend a great deal of time analyzing market data, there are some dates that are easy to remember – October 29, 1929, March 23, 2000 (the date of the 2000 bubble peak in the S&P 500), August 12, 1982 (the 1982 low), October 19, 1987, and so forth. Certain years are memorable of course, marking the beginning or end of recessions, major market movements, major economic events, and the like. But individual dates are generally forgotten unless they represent some sort of outlier.

At any given time, there are a good number of historical points where market data have been generally similar in terms of broad valuation and market action, and these references provide specific examples that we can look at as we evaluate the distribution of likely market returns and risks.

In reviewing the status of the market late last week, the condition of the data was something of an anomaly in that regard. On the valuation front, stocks are presently overvalued, but to levels that we've observed at least several times in history. The anomaly relates to market action, where we can no longer find a single historical instance where stocks were more overbought on the combination of short- and intermediate-term measures we respond to most strongly. Indeed, only one instance comes close, which is November 28, 1980.

Now, if that date doesn't ring a bell, I have to admit that it didn't resonate with me either at first. On that date, the stock market was just a few months into a fresh economic recovery following the 1980 recession, employment conditions were just beginning to improve, capacity utilization was picking up, the Purchasing Managers Index had just moved back over 50, and stocks were certainly not overvalued on the basis of normalized earnings or cash flows. Indeed, the P/E multiple of the S&P 500 was just over 9, on the basis of both trailing and normalized earnings. Advisory sentiment was not strenuously bullish either, so there was little to identify it as a date to remember.

As it happened, however, November 28, 1980 was the peak of the furious advance in S&P 500 driven by enthusiasm over "less bad" economic news, though with little proven economic strength. It was the last day of the 1980 bull market. The economy later proved to have been in a short lull within a double-dip recession, taking stocks to their final lows in 1982.

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