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John Hussman puts the smackdown on the "Stocks are cheap here" thesis so popular amongst certain types of analysts:

Overvalued, overbought, and overbullish conditions have generally resulted in disappointing market returns, regardless of other features of market action. Yet the past several weeks have quietly added a new ingredient: Treasury bill yields are now higher than they were 6 months ago, and Treasury yields of all maturities have popped higher in recent weeks.

While this might seem like a trivial and low-magnitude event, it actually contributes to a syndrome that has invariably been negative for near-term market outcomes (not to mention the negative long-term results that overvalued market conditions have historically produced).

As of last week, the Market Climate for stocks was characterized by unfavorable valuations, moderately favorable market action, and a combination of overvalued, overbought, overbullish conditions that has historically been associated with short-term returns below Treasury bill yields. As noted above, even the modest upward pressure on Treasury yields in recent weeks has made the present risks far more pointed...

Of course, the key is how we define these measures - that will certainly determine how often these elements all line up. Hussman defines them as follows:

  • Overvalued: S&P 500 price/peak earnings greater than 18
  • Overbought: S&P 500 at a 4-year high, and at least 5% higher than its level 6 months earlier
  • Overbullish: Investors Intelligence percentage of bullish advisors above 53%
  • Yield pressure: 3-month Treasury yield higher than its level of 6 months earlier
  • None of those metrics is particularly extreme; it's the concurrent combination that presents an increasing risk factor.

    Surprisingly, prior to the most recent example (November 17, 2006, December 8, 2006 and January 12, 2007), there have only been 8 previous periods when these elements all lined up together:

    April 30, 1965
    December 18, 1972 / January 5, 1973
    August 14/21 1987
    April 3, 1998
    April 23, 1999
    July 2/16, 1999
    December 23/31 1999
    March 24, 2000

    Here's what they look like on a long term chart:

    Overvalued, Overbought, Overbullish

    hussman chart

    Chart courtesy of Hussman Funds

    The market performance subsequent to this signal is detailed at Hussman's site.


    Source:

    Hazardous Ovoboby!
    John P. Hussman, Ph.D.
    January 15, 2007
    http://www.hussmanfunds.com/wmc/wmc070115.htm

    Source: Overvalued, Overbought, Overbullish Conditions