Price-slashing is in vogue on the UK’s high streets, attracting hordes of shoppers from overseas. China’s middle classes are snapping up bargains in post-Christmas sales, UK newspapers report.
But the stock and bond markets currently offer poor value by comparison.
In his latest weekly newsletter, fund manager John Hussman estimates prospective 10-year returns on the S&P 500 index at 4.9% per annum, lower than at any time in the last seventy years, with the exception of the period around the technology bubble at the turn of the millennium.
Hussman derives his forward-looking equity market return estimates from the cyclically adjusted price/earnings ratio on the S&P 500 index (also known as “CAPE” or the “Shiller P/E”), which uses an inflation-adjusted, ten-year average earnings measure.
It’s clear from the chart below that CAPE has good long-term forecasting power. Back in 1999, when CNBC and investment banks’ brokerage arms were preaching rising stock prices to the masses, CAPE predicted negative returns from equities over the next decade: an event that subsequently transpired. Although equities are less expensive now than twelve years ago, they aren’t cheap or even fairly valued by historical standards, either.
Source: Hussman Funds
But if 4.9% a year from stocks doesn’t sound appetising and won’t be enough to plug the looming funding gap at many pension plans, the current yields on bonds are even lower: 2% on 10-year Treasuries, below 3% on 30-year bonds and below 4% on high-quality corporates.
“We presently have one of the worst menus of prospective return that long-term investors have ever faced”, Hussman summarises. “The proper response is to accept risk in proportion to the compensation available for taking that risk. Presently, that compensation is very thin.”
Hussman’s model is one for long-term asset allocators. It has little short-term predictive power, and Hussman admits that in coming weeks and months markets may be poised to rally. However, for a longer-term bullish view on equities to be justified, he says, valuations need to decline further. For this to occur, Hussman suggests, it’s important that central banks stop distorting market mechanisms and allow asset prices to find a clearing level, even if that means taking banks into receivership and imposing losses on their bondholders.
“At present,” says Hussman, “we have a situation where saving is discouraged by desperately low interest rates, where unproductive uses of capital are not discouraged because the bar is so low, and where central banks recklessly facilitate economic stagnation by bridging the gap between a puddle of unrewarding savings and a mountain of unproductive speculations.” Near-zero interest rates are less the solution than the problem, in other words.
Perhaps 2012 will be the year in which the intensifying standoff between two groups of people comes to a head: those who would prefer to see an end to the use of taxpayers’ money in repeated bailouts of the financial system, and those institutions—central banks and the IMF, prompted by incumbent politicians in all Western economies—whose job it seems to have become to prop up asset prices indefinitely.
If government interventions are held back or stopped—perhaps as a result of one of this year’s important national elections—and stock prices are allowed to fall to their clearing level then, as Hussman says, “events will unchain the global economy from an irresponsible past and open the gates toward a prosperous future”. Amen to that.