This Looks A Lot Like 1930
Inquiring minds are once again reading excellent commentary by John Hussman, including his post Strenuously Overbought.
Last week, we closed out our modest "anti-hedge" in index call options, which we’ve carried in the Strategic Growth Fund during recent months, and we moved back to a fully hedged investment stance. I should note that we’re not calling or predicting a market decline in this particular instance. Rather, we’re tightening our defenses because the overall conformation of evidence we observe here has generally not been followed by an acceptable return/risk profile, on average.
My discomfort about strenuously overbought and moderately overvalued conditions overlaps with skepticism about the US economic “recovery,” which appears to be nothing but an artifact of government spending, while intrinsic economic activity remains weak. Stimulus-induced “strength” is unlikely to propagate because, as I've noted before, economic recoveries are invariably led by expansion in debt-financed forms of spending such as gross domestic investment and durable goods.
These classes of spending tend to lead other forms of economic activity by nearly a year, and it’s difficult to expect this in an environment of heavy continued deleveraging pressure. Rather than abating, foreclosures and mortgage delinquencies are setting further records (pressured even more by continued net job losses), and we have now hit the point where Alt-A and Option-ARM resets are beginning (after a lull in the reset schedule since March). We know that post-crash markets feature partial recoveries followed by a very extended period of sideways movement. To expect an entirely different result in this instance -- to assume that this is a typical post-war recovery and that everything is back to normal -- seems hopeful to say the least.
The percentage of bullish investment advisers now rivals that seen at the 2007 peak. Stocks are strenuously overbought. The S&P 500 is overvalued to the extent that we now expect just a 6.6% annual total return over the coming decade (a level that except for the period since the mid-1990s has corresponded more to bull market peaks than bases for sustained advances). Historically, such combinations of overbought, overvalued, overbullish evidence have generally been unrewarding, so we don't even need to consider special cases. However, recent (and in my view continuing) economic conditions are nothing if not a special case, and the historical parallel I’m most concerned about is the one with the closest overlap to this one.
Comparison To April 1930
Hussman has a series of four charts comparing the situation now with 1930. So as to induce you to read Hussman's entire article I will only post two of them.
S&P Weekly Chart December 2005 to Present 
Dow Weekly 1928 to Spring 1930
History Rhymes
History sometimes repeats and sometimes rhymes, but that's not a guarantee it does so again. Nonetheless, valuations are stretched to ridiculous levels and so is sentiment. These aren't conditions in which (on average) it pays to be long.
E-Wave Update
Here's a chart that I've been following. The chart is from September 9 but I can discuss differences.
Click to enlarge
The above chart shows several different possibilities of what may happen. These aren't the only patterns in play, which is why I've refrained from commenting until now. However, the odds are increasing that one of these patterns is it, thus the following discussion.
That rising wedge can now be counted as an a-b-c-d-e bearish rising wedge, possibly representing a massive corrective "B" wave up. With that labeling, the five waves down into March is an "A".
In this scenario, wave "C" will take out the March low. This is the most bearish outlook and one that I'm increasingly in favor of. It would match what happened in the Great Depression.
A second likely possibility is a "bottom may be in but we aren't going anywhere" for a long time scenario. Perhaps new lows are made, perhaps not. Such a scenario would play out similar to the "Lost Two Decades" In Japan. Please see my October 23, 2008, post S&P 500 Crash Count Compared To Nikkei Index for details.
The least likely possibility, but one that needs to be considered, is a scenario in which the rising wedge breaks north in a sustained way (as opposed to temporary headfake). Were this to happen, it'd likely be in connection with a collapsing US dollar. Although a possibility, bearish US-dollar sentiment is so extreme that it can't be considered a strong likelihood at this point.
Fundamentally, technically, and sentimentally conditions are ripe for a strong retrace of a major portion of this move up. But.... that doesn't mean it will happen.
Copyright 2009 Minyanville Media, Inc. All Rights Reserved.
If you want an historical prescedent, what happened in 2007 / 2008 relates almost exactly in events and market response to the credit collapse in 1907, which had recovered all of its drop within a year or so.
To me it is also about the debt bubble. And I don't think they can reflate it, unless the consumer starts spending again. But now without the home equity, or the manufacturing jobs.
In the 1930s, first there was deflation. Then Roosevelt reset the dollar/gold ratio. There was not inflation due to economic conditions, but rather extreme policy. Japan I believe was stimulus-deflation, stimulus-deflation, ... And now still a large amount of debt (Steve Keen).
He said it went from 500% personal/GDP, and 50% gov./GDP (in the 1980s) to 450% personal/GDP to 200% gov./GDP now. So all the gov. spending fixed nothing. Scary!
[Once deflation takes hold, I think we can also hit the 500%, maybe even break the record!]
After the point of recognition, the real question will be what else will be tried. Both the 1930s and Japan were long periods of poor GDP growth. Will we swap debt for equity? will we restructure bank debt, now that the big fish have been paid?
In my opinion the key will be to watch out for policy steps. Without more radical policy steps we will be looking at at least a decade of weak GDP.
All just opinion
For full disclosure, I see the correlations in the 1930's collapse. The bullet point version
*Real estate boom/bust (including insane Florida boom)
*Demographics - the aging of two large population bubbles
*Maturing of new technologies - Radio/communication/transportation advances then/Intermet now
*Debt crisis/Financial "innovation" - the original interest only loan originated in the '20s and ended after the crash of the 30's.
I'd be interested in your bullet point summary of why you see 1907.
and i always like hearing what john hussman has to say -
combine all that with the charts etc, and it's great!
thanks!
histroy doesnt repeat but it rhymes..... there is nothing similar between 1930s and today.... other than the fact that the pundits continue to be as misinformed and stupid as ever.......
Which will put 3 where your C is.
