Nice Reading....
Excerpted from the April 2000 issue of Hussman Econometrics:
In recent months, we have made the rather bizarre assertion that the Nasdaq is likely to lose somewhere between 65% to 83% of its value from its recent highs to its ultimate bottom. In the March letter, we reviewed the S&P 500 technology stocks, noting that the P/E on those stocks had reached 70, compared to a 1975-1995 average P/E of just 17. Meanwhile, the price/revenue ratio for those stocks had reached 6.8, compared to a 1975-1995 average of just 1.1.
The argument of the “new economy” crowd? Yes, but they're great companies (“good stocks”), you would have been wrong to be against them (“records of the past had proved an undependable guide to investment”), what drives stocks is not the valuation multiple, but only whether these companies beat earnings estimates (“from dividends, from asset values, and from earnings, to transfer it almost exclusively to the earnings trend”), a “new economy” warrants entirely different valuation methods (“the standard of value had been raised”), and anyway, a stock is worth whatever price investors are willing to pay for it (“the new-era based its standards of value on the market price”). “Hence”, as Graham & Dodd recounted about the run-up to the 1929 crash, “all upper limits disappeared, not only upon the price at which a stock could sell, but even upon the price at which it would deserve to sell.”
Every security price effectively boils down to assumptions about 1) the expectation of future growth rates, and 2) the expected long term return. Those expectations are embedded in the valuation multiple of the stock. A high valuation multiple may imply either unusually high growth expectations, or the willingness to accept very low long-term rates of return. But an excruciatingly high valuation multiple almost by necessity implies both. In a bubble, those two factors become completely detached from reality, and expectations about future returns become increasingly reinforced not by fundamental data, but by price action alone.
We have frequently noted the detachment of investor expectations from the underlying long-term return on stocks. While polls suggest that investors expect a 19% annual return on stocks over the next decade, the fact is that S&P 500 earnings have grown at just 7% annually, not only over the past decade, but as far back as 1950. If the current P/E of 34 on the S&P retreats to a still above-average level of 17 over the next decade, the S&P 500 will show zero price appreciation over the next 10 years. Recall that the Dow reached 1000 in 1966. In 1982, the Dow bottomed at 777. Zero stock market returns over a long period of time would certainly not be unprecedented.
After the Nasdaq plunge of recent days, the entire thrust of commentary has turned to whether a bottom has been set, or whether we might see a few more days of selling pressure. It is unlikely that Nasdaq investors will be treated so well. We continue to view stocks as being in a bear market, and bear market psychology typically evolves something like this:
"This is my retirement money. I can't afford to be out of the market anymore!"
"I don't care about the price, just Get Me In!!"
"It's a healthy correction"
"See, it's already coming back, better buy more before the new highs"
"Alright, a retest. Add to the position - buy the dip"
"What a great move! Am I a genius or what?"
"Uh oh, another selloff. Well, we're probably close to a bottom"
"New low? What's going on?!!"
"Alright, it's too late to sell here, I'll get out on the next rally"
"Hey!! It's coming back. Glad that's over!"
"Another new low. But how much lower can it go?"
"No, really, how much lower can it go?"
"Good Grief! How much lower can it go?!?"
"There's no way I'll ever make this back!"
"This is my retirement money. I can't afford to be in the market anymore!"
"I don't care about the price, just Get Me Out!!"
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