The Turtle And The Pendulum

Summary

• Investment returns over shorter segments of the market cycle are driven by investor psychology, including the frequent attachment of that psychology to day-to-day developments that have very little bearing on long-term cash flows.
• Chart shows the ratio of nonfinancial market capitalization to gross value-added – what I call MarketCap/GVA – in data since 1928. It remains our most reliable valuation measure, based on correlation with actual subsequent 10-12-year S&P 500 total returns across history.
• At present, our baseline estimate for real U.S. GDP growth over the coming 4 years is about 1.5% annually, with the caveat that recessions typically induce a striking shortfall from these estimates.
• Extreme valuations, unfavorable market internals, lopsided bullish sentiment, and a motherlode of overextension syndromes hold us to a defensive outlook here.

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The market is a pendulum that forever swings between unsustainable optimism, which makes stocks too expensive, and unjustified pessimism, which makes them too cheap. The intelligent investor is a realist who sells to optimists and buys from pessimists.