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Excerpt from fund manager John Hussman's weekly essay on the US market:

Charles H. Dow, who edited the Wall Street Journal a century ago, once observed, "It is impossible to tell in advance the length of any primary movement, but the further it goes, the greater the reaction when it comes, hence the more certainty of being able to trade successfully on that reaction… The best way of reading the market is from the standpoint of values. To know values is to comprehend the meaning of movements in the market." Dow's successor at the Wall Street Journal was William P. Hamilton, and was also a brilliant observer of the market. Hamilton observed that bull markets generally occur in three phases. As Richard Russell summarizes: “Phase one is the rebound from the depressed conditions of the previous bear market. Here stocks return to known values. In the second and longest phase, shares advance in recognition of improving business and a rising economy. During the third phase they spurt skyward on the hopes and expectations of a continuing rosy future… The low-priced ‘cats and dogs' historically make great moves in this third phase…” As another follower of Dow, Robert Rhea, once wrote: “The final stage is sometimes recognizable because people then buy stocks simply because they go up, and because other people are buying them.”

With the S&P 500 currently trading at nearly 18 times fresh record earnings, on record profit margins, it seems clear that the current bull market is well into its third phase. To anyone who examines more than one or two decades of market history, even a multiple of 18 is very rich by historical measures, and can't be reconciled simply by reference to interest rates or inflation. On closer inspection, of course, valuations are even more hostile. Over the past three years, profit margins have widened to record levels, which has detached P/E ratios from other fundamental measures – such as price/revenue, price/dividend, and price/book ratios. The S&P 500 is currently about double its historical norms on those metrics. That isn't a forecast that stocks have to eliminate that valuation gap, but it certainly does suggest that stocks are priced to deliver unsatisfactory long-term returns from these prices. It bears repeating that if profit margins were at normal levels – even on the basis of profit margins that prevailed during the 1990's (indeed, anytime prior to the past 3 years) – the price/earnings ratio of the S&P 500 would currently be nearly 25. Unless investors want to speculate on the notion of a “permanently high plateau” in profit margins, the stock market is strenuously overvalued at present. Neither current earnings nor “forward” earnings should be considered – in themselves – as anything close to robust or reliable metrics of value here...

Given the overwhelming historical evidence that profit margins normalize over time, long-term investors should build that expectation into the prices that they pay for stocks, which after all, are nothing but a claim on a stream of future cash flows. A market P/E of nearly 25, on the basis of normalized profit margins, doesn't allow any margin of safety. Still, we have to recognize, as Richard Russell once wrote, that “it is not history, facts, or intelligence that guide most investors through the final phases of a bull market; it is hopes and wishes.” On that basis, it's not clear that the current speculative blowoff is over, or doomed to end in short order, so long as there are dangling strands of hope.

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Source: John Hussman: Raging Bull Leaves No Margin of Safety