Laszlo Birinyi garnered some attention this week with his prediction that the S&P 500 could rise to 3,200 over the next two years (a roughly 50% increase from today's levels). Birinyi has been one of the most outspoken bulls throughout this entire bull market, which has meant that for the past six-plus years, he's been mostly correct.
John Hussman's view is dramatically different. He wrote this week that based on the valuation of the average stock, the stock market is at "the single most overvalued point in history for the broad market." That, coupled with meaningful declines in market internals (more on this shortly) and "scarce bearish sentiment" lead him to conclude that the current market belongs in the company of the precise market highs of 1973, 2000, 2007 and 1929. Hussman has been one of the most relentlessly bearish voices throughout this entire bull market, which has meant he's been spectacularly wrong for the past six-plus years.
What to make of these incredibly divergent views of the market?
First, it reinforces the point SMI makes frequently about there always being two sides to every market story. There have to be in order for there to be a balance of buyers and sellers. When too many people tip to one side of the aisle, the market's price moves until balance is restored. It takes buyers and sellers in some sort of rough balance to make a market. So it shouldn't surprise us that there are experts — brilliant, successful ones — on completely opposite sides of an issue like this. This is normal, not the exception.
Second, that fact is exactly why we believe prediction-based investing is a crazy approach. How can you possibly know which experts are right and which are wrong? This is why SMI consistently focuses on each individual creating a personal long-term plan and using that "inside-out" compass as the basis of their investing decisions.
Does that mean we should necessarily ignore all investment analysis, given that we know much of it will be flawed? I don't believe so. Long-time readers of SMI know that we occasionally delve into where we think the market stands in its bull-bear cycle. While we pepper that with a lot of "we don't know," we also recognize that there are times when it's appropriate for at least certain types of investors to make adjustments based on these types of factors.
For example, in our September 2013 cover article, The Retirement Investing Challenge: Keeping Up With Inflation While Limiting Risk, we wrote about one way retirees might try to loosely tailor their portfolio withdrawals (specifically their stock sales) to take advantage of the market's long-term bull/bear cycle. This approach involved selling more stock and keeping larger cash reserves as it appears stocks are reaching the late stages of a bull market, in an effort to hopefully avoid doing much of any selling during the subsequent bear market. This is just one example of why we think it's appropriate to keep an eye on broader market conditions, despite the fact that most of the time our counsel is to not make many adjustments from your long-term plan based on that information.
With that in mind, let's look closer at the cases made be Birinyi and Hussman and see what we can glean from them about the market's condition.
Birinyi's Bullish Case
While it's tempting to just give greater weight to Birinyi's view because he's been right so far in this market cycle and Hussman has been wrong, that's a dangerous approach to take. Essentially, Birinyi's view boils down to this: past market evaluation tools are outdated, so we need to analyze the current bull market in the context of other recent, Fed-driven bull markets (rather than relying on past historical averages). Based on that approach, he simply states that if the current market were to follow the 1990s bull path, it would rise roughly 50% over the next two years.
Simplistic? A bit. But frankly, it's not that dissimilar from the point SMI has been making about this bull market for years — the Fed has taken us on this boom/bust cycle three times now, where they pump up stock market valuations via easy money until the market collapses into a deep bear market. A third steep bear market at the end of this latest cycle seems inevitable. But first, this bull market is likely to run farther and longer than most people expect, because the monetary policy measures have been the biggest ever.
So far, that narrative has played out exactly as SMI, Birinyi, and other bulls have expected. The thing is, it was one thing to say that in 2011 or 2012. Now we're moving into late 2015. This bull market isn't going to go on forever. And Birinyi suggesting it will last two more years simply because the biggest market outlier ever extended that long seems like flimsy support to build an argument upon.
We think it's clear that risk has been increasing as this bull market has aged. This is why SMI has been cautioning for some time that gradually paring back portfolio risk would be prudent, particularly for anyone over-extended in riskier strategies (like Sector Rotation). We've encouraged most SMI readers to move gradually from Upgrading-heavy portfolios to portfolios more evenly balanced with Dynamic Asset Allocation, and spent considerable effort last year detailing the risk-management advantages of a portfolio invested 50% in DAA.
It's entirely possible that this bull market could go on another year or two, as Birinyi suggests. We don't believe anyone is going to be able to precisely determine that end point, in part because it's been the stimulus of the central banks that has propelled the market this far, and what they've done in recent years has never been tried before. Besides, we're trend-followers, so we're not even philosophically inclined to try to guess when it will end. Our approach is to try to create strategies that will respond quickly enough when conditions change, and to encourage readers to have positioned their portfolios in such a way that they can ride out the seemingly inevitable storm that will come when this bull market does finally end.
Hussman's Bearish Case
When someone is wrong for as long as Hussman has been, there's a tendency to write them off as having cried wolf too many times. Just remember that the wolf did eventually show up at the end of that story!
The thing that has been grabbing my attention in Hussman's recent writings — and what distinguishes them from his earlier bearish stuff from several years ago — is he has moved beyond the traditional valuation fears he's always focused on to add an emphasis on the market's current internal action and health. Some of those internal measures are things I've been watching with increasing discomfort for a while as well.
This market has been essentially flat so far in 2015 and is up only about 4% over the past year-plus (dating back to the middle of 2014). That doesn't mean anything in and of itself, but long bull markets do tend to end in extended "rolling tops" (as opposed to the sharp, V-shaped endings of bear markets). I'm not saying the past year IS this sort of rolling top — it's impossible to say that until it's over. I'm just saying the current pattern certainly could fit the typical bull market ending when we look back in hindsight.
Another market internal that is making Hussman uncomfortable is the declining number of advancing stocks. He notes that less than half of all stocks are above their 200-day moving averages, which means more than half the market is already declining. Again, by itself, that's not necessarily compelling. But it does indicate the market isn't healthy. And when you pair that up with recent highs in the market indexes, the rich valuations of the market (by one common measure, the market is in the 93% range of historical overvaluation, surpassed only by the 2007 peak, the 1929 peak, and the end of the 1990s tech bubble), and the low amount of bearish sentiment, he finds that those combinations have only been found together historically at past market peaks. The lone exception: the 1998-1999 period, which interestingly is the period Birinyi cites as his support for further bullishness.
The point of this discussion isn't to scare anyone or convince you to make changes to your portfolio. In fact, for most SMI readers, I suspect the right approach is the same as what I wrote this past January:
For most readers, they're best served by figuring out a portfolio mix they can stick with in good markets and bad, then just riding that out. The 50/40/10 portfolio was specifically designed to be that type of "all weather" portfolio, with certain pieces that should excel during the bull phase and others that should excel during the bear phase. If you're using that type of portfolio mix, we feel like you should be able to hold up pretty well whenever the next bear comes.
The article that came from, Should My Strategy Mix Change As We Move Through Bull/Bear Market Cycles?, as well as another written the first week of January, New Year Musings, may be helpful for anyone reading this who feels like maybe they need to make some tweaks to their portfolio in preparation of the next bear market.
Of course, many SMI readers have already put in the effort to prepare themselves by creating a long-term plan and positioning their current portfolio so that it's ready for the next bear market, whenever that may come. If that's you, awesome, you don't need to do a thing! But if you don't have that type of confidence, now is the time to prepare — before the storm comes. Of course, getting more defensive generally means lower profits if the bull market continues. But as we constantly weigh the risk/reward ratio the market appears to be offering, we know that the later we get into a bull market, the more that balance begins to tilt toward risk and away from reward. The time to be aggressive is when the last bear market is still close behind in the rear-view mirror. The longer the good times go on, the more we have to consider how we should appropriately prepare for the next bear.
We'll likely explore this topic some more in the next issue of SMI. With that in mind, if you have comments or questions about any of this, please voice them in the comments section below.