PY - This Is Where You Start Bear Markets From

2024-05-08 07:20:00 ET

Summary

• As of last week, the total return of the S&P 500 was even with 3-month Treasury bill returns since the valuation peak of January 2022, more than two years ago.
• We have totally full employment, totally wonderful profit margins. All the things you would not want to start a bull market from. This is where you start bear markets from.
• An improvement in the uniformity of market internals would not improve our expectations for long-term returns, nor would it reduce the risk of severe market losses over the completion of this cycle.

Today is in the top percent on the Shiller P/E of all time, and when you start from this level, you have a very hard time going up materially. You’ve done it once or twice, but you’ve only done it for a while: in the last gasp of 1929; in the last gasp of 1999; and notably and most impressively in Japan, where maybe for two and a half years you kept going. And in each case, they ended incredibly badly. So, the price you paid for bucking that kind of law was a very high price.

In general, if you want to make a lot of money, and you want to have a long bull market, you need high unemployment, depressed profit margins, and depressed P/Es. It’s beautiful double-counting. Multiplying depressed earnings by a low P/E is really double counting. Multiplying peak earnings by a high P/E, which is what we’re doing today, is also double jeopardy the other way. And the gap between peak P/E times peak profits all the way to trough P/E times trough profits, that’s a big run. That’s the kind of thing we saw ending up in 1974 and 1982, and to some extent in 2009. Yes, it was somewhat higher in 2009 than 1982, but the discount rate, interest rate, everything else had shifted, and it was down an awful lot from its peak.

But it feels good at the top of the spike, always feels terrific. And people always torture the logic to think, like in 1929, that it’s a “new high plateau.” 1929 – in the most predictive model that I have come across, which is run by Hussman – the only one that is about the same is 2021, and a little bit higher, both of them, than today. These are not good times to start a 10-year bull market, and yet, one or two bulls are saying whoopee, this is the beginning of a great bull market.

We have totally full employment, totally wonderful profit margins. All the things you would not want to start a bull market from. This is where you start bear markets from. Great bull markets start with exactly the opposite. But it always feels wonderful. Peak profit margins, getting there takes years, and it feels nice. And so you’ve got a great track record. You can’t get to peak margins without leaving a terrific track record. You’ve got the peak P/E, so you feel wonderful, the stock market has gone up and up and up and up. So everyone feels great, and that’s how you get to a market peak. You feel great about everything. Of course, almost by definition.

When do you start going down? You still feel great. You just don’t feel quite as great as you felt the day before. That’s why it’s so damn hard, at both ends.

Jeremy Grantham, GMO, The Insightful Investor , March 19, 2024

As of last week, the total return of the S&P 500 was even with 3-month Treasury bill returns since the valuation peak of January 2022, more than two years ago. In our view, investors continue to “grasp at the suds of yesterday’s bubble,” ignoring extreme valuations, lopsided bullish sentiment, emerging pressure on profit margins, economic conditions at the border of recession (though the evidence is not yet decisive), and most important for near-term outcomes, unfavorable market internals.

An improvement in the uniformity of market internals would not improve our expectations for long-term returns, nor would it reduce the risk of severe market losses over the completion of this cycle. Still, improved internals would encourage a more neutral or even constructive near-term outlook (albeit with position limits and safety nets). For now, rich valuations, unfavorable market internals, and other elements of our discipline hold us to a defensive outlook....

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