Crescat Capital claims US large cap stocks are the most overvalued in history, higher than prior speculative mania market peaks in 1929 and 2000.
Their 25-page presentation makes a compelling case, with numerous charts. It's worth your time to download and investigate the report.
Six Ways Stocks Most Overvalued in History
- Price to Sales
- Price to Book
- Enterprise Value to Sales
- Enterprise Value to EBITDA
- Price to Earnings
- Enterprise Value to Free Cash Flow
Here are a few snips from the report.
Bear Market Catalysts
There are many catalysts that are likely to send stocks into bear market in the near term. A likely bursting of the China credit bubble is first and foremost among them. Our data and analysis show that China today is the biggest credit bubble of any country in history. We believe its bursting will be globally contagious for equities, real estate, and credit markets.
The US and China bubbles are part of a larger, global debt-to-GDP bubble, which is also historic in scale, and the product of excessive, lingering central bank easy monetary policies in the wake of the now long-passed 2008 Global Financial Crisis. These policies failed to resolve the debt-to-GDP imbalances that preceded the last crisis. Now, easy money policies have created even bigger debt-to-GDP imbalances and asset bubbles that will precipitate the next one.
We are in the very late stages of a global economic and business expansion cycle with investor sentiment reflecting record optimism typical at market peaks, a sign of capitulation at the end of a bull market.
Crescat is positioned to profit from the coming broad, global cyclical market and economic downturn that we foresee. We strongly believe that our global equity net short positioning in our hedge funds will be validated soon.
Cyclical PE Smoothing
It is critical to use cyclical smoothing to accurately gauge market valuations in their current and historical context when using P/E.Yale economics professor, Robert Shiller, received a Nobel Prize in 2013 for proving this fact so we hope you will believe it.
The problem with just looking at trailing 12-month P/E ratios to determine valuation is that it produces sometimes-false readings due to large cyclical swings in earnings at peaks and valleys of the business cycle. For example, in the middle of the recession in 2001, P/Es looked artificially high due to a broad earnings plunge. P/Es can also look artificially low at the peak of a short-term business cycle, which can produce what is known as a “value trap”, such as in 2007 during the US housing bubble and such as we believe is the case today in China, Australia, and Canada.
Shiller showed a method for cyclically-adjusting P/Es using a 10-year moving average of real earnings in the denominator of the P/E. Shiller’s Cyclically-Adjusted P/E, called CAPE multiples have been better predictors of future full-business-cycle stock market returns than raw 12-month trailing P/Es. Shiller showed that markets with historically high CAPEs lead to low long-term returns for long-only index investors.
Shiller CAPEs are fantastic, but they can be improved by including an adjustment for corporate profit margins which makes them even better predictors of future stock price performance and therefore even better measures of cyclically-adjusted P/E for valuation purposes.
Shiller’s CAPEs simply need an adjustment for profit margins because margins are a key element of earnings cyclicality. We can understand this by looking at median S&P 500 profit margins in the chart below. For example, even though profit margins were cyclically and historically high during the tech bubble, they are even higher today. In the same spirit of Shiller’s attempt to cyclically adjust earnings to determine a useful P/E, CAPEs need to be adjusted for cyclical swings in profit margins.
When we multiply Shiller CAPEs by a cyclical adjustment factor for profit margins (10-year trailing profit margins divided by long term profit margin), we get a margin-adjusted CAPE that is not only theoretically valid but empirically valid as it proves to be an even better predictor of future returns than Shiller’s CAPE!
Credit goes to John P. Hussman, Ph.D. for the idea and method to adjust Shiller CAPEs for swings in profit margins.As we can see in the Hussman chart below, margin-adjusted CAPE, shows that today’s P/E ratio for comparative historical purposes is 43, the highest ever! The 1999 peak P/E was 41 and the 1929 P/E was 40. Once again, we can see that today we have the highest valuation multiples ever for US stocks, higher than 1929 and higher than 1999 and 2000!
It's easy to discard such talk, just as it was in 2000 and 2006. People readily dispute CAPE, concocting all sorts or reasons why it's different this time.
The most common reason is interest rates are low. We also hear "stocks are cheap to bonds" which is like saying moon rocks are cheap compared to oranges.
I do not know when this all matters. And no one else knows either. What I am sure of is that it will matter.
I don't know when, nor am I sure how it happens.
It could play out as a crash or stocks can decline over a period of 6-10 years with nothing worse than a 15% decline in any given year, accompanied with several sucker rallies leading people to believe the bottom is in.
Some might ask: If you don't know when or how, of what use is such analysis.
The answer is that history shows this is a very poor time to invest in stocks. That does not mean that they cannot go higher (and they have).
History also suggests that people who invest in bubbles start believing in them. People believe in bubbles because they have to in order to rationalize their investments.
Others know full well it's a bubble, but they think they can get out in time. Historically, only a few do, because most are conditioned to "buy-the-dip", and keep doing so even after it no longer works.
So if you are looking for a reason to stay heavily invested in this market, you have one. But don't fool yourself, this is the most expensive market in history.
Mike "Mish" Shedlock