Arguments for a stock market correction clutter financial publications every morning. All will be correct at some point, but as Keynes said, in the long-run we'll all be dead. But what's different about this one is not just the magnitude of the correction, but where it begins. "During the journey of Empress Catherine II to Crimea, Prince Grigory Potemkin, the governor of the region, erected fabricated villages along the Dnieper river" That's Wall Street analyst and fund manager John P. Hussman whose outlook is dire than any Wall Street bear going around. (See also: Bear Market Ahead: What 5 Big Investors Forecast)

Citing fundamentals, cash distribution, and valuation as the source of stock market gains, Hussman points out that, while historically high, all are drastically slowing to what many would call a point of no return. "Consider these drivers today. Combining depressed growth prospects with an S&P 500 dividend yield of just 2.0%, the likelihood is that over the coming 10-12 years, even a run-of-the-mill reversion of valuations will wipe out the entire contribution of growth and dividend income, resulting in zero or negative total returns in the S&P 500 Index on that horizon, with an estimated interim market loss on the order of -60%," Hussman said in his post. 

How Expensive Is the S&P 500?

The S&P 500 traded at a record high Monday, trading to within a few ticks of 2500. With this, it dragged the forward 12-month EPS to a record high and the 12-month price to earnings ratio to levels not seen since the pre-Dotcom era. But even these stretched levels don't uncover the extent of the over-valuation. "Notice that the distinction between today and the 2000 peak is in the breadth of overvaluation across individual stock," Hussman said in an August post. 

"As of last week, with the exception of the richest decile of stocks, where median valuations were higher only during the January 2000-March 2001 period (followed by median losses exceeding -80% for those stocks), every decile of S&P 500 components is currently at or within 2% of its most extreme valuation in history."

Source: Hussman Funds

Not Alone

While the extent of Hussman's call is frightening, he is not alone in calling for a stock market correction. Deutsche Bank said recently that the probability of a recession is at the highest level in ten years saying a flattening yield curve means investors are bracing for tough times ahead by investing in longer term Treasuries, which has pushed the yield curve to levels last seen before the Great Recession.

Take Away

September 4 marked the 300th consecutive trading day the S&P 500 has been above its 200-day moving average, which is the 15th longest since 1923, and while valuations continue to stretch and the number of people calling for a correction grow, so does the number of those who have been wrong. 

However, if Hussman is correct, then the Potemkin villages will, in fact, be as valuable as those pieces of paper representing the S&P 500: "temporarily glorious and impressive on the surface, but backed by much less than investors had imagined was there."

 

 

 

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