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Strategies & Market Trends : Zeev's Turnips - No Politics -- Ignore unavailable to you. Want to Upgrade?

To: Steve Lee who wrote (13861)	12/17/2001 1:27:53 PM
From: Crimson Ghost	Respond to of 99280

The respected Hussman Advisory Service has just moved to crash warning because of unfavorable valuations and surging bond yields. "The Market Climate has shifted to a Crash Warning. I don't want to overemphasize the risk of a crash. It simply should not be ruled out. Market conditions currently match those seen in only about 4% of market history - overvaluation, unfavorable trend uniformity, and hostile yield trends (particularly in long-term interest rates). Every historical crash of note has emerged from this single set of conditions. A Crash Warning does not mean that the market must crash, or that a crash should be strongly expected. It does mean that downside risk should be taken seriously. As I've frequently noted, a market crash, first and foremost, is driven by a sharp increase in the risk premium demanded by investors. When investors demand a higher rate of return from bonds for example, they cannot force the stream of future payments up. The only way to obtain a higher long-term return is to drive the price down, so that the fixed stream of payments delivers a higher percentage return on the investment. Similarly, when investors demand a higher return from stocks, they can't force the growth rate of earnings up at will. Again, the only way to obtain a higher long-term return is to drive the price down and the yield higher. With the dividend yield on the S&P 500 at just 1.4%, even an increase in yield to 2% would require a 30% plunge in market values. The price/peak-earnings ratio on the S&P 500 is 21. The historical norm is 14. Though inflation and interest rates are low compared to the past few decades, they were lower through most of historical data prior to the mid-1960's. In contrast, no other market cycle in history has seen the price/peak-earnings ratio at 21. The 1929, 1972 and 1987 pre-crash peaks never exceeded 20 times peak earnings. Claims that stocks are fairly valued due to low interest rates are based on limiting the data set so that current interest rates are the lowest in the entire sample. That's just careless analysis when more complete historical data is readily available." Here is why a Crash Warning specifically requires three conditions. First, overvaluation. Overvaluation implies only that risk premiums are low, and that stocks are priced to deliver a poor long-term rate of return. It does not mean that stocks must necessarily decline over the near term, or even over a period of a several years. Second, unfavorable trend uniformity. This implies an underlying skittishness, rather than a robust preference to take on market risk. Finally, rising yield trends in long-term interest rates, utilities, corporate bonds and other securities signal an environment in which risk premiums are being pressured higher. Combine these three elements and you have a Crash Warning. Low risk premiums on stocks, an underlying skittishness of investors to take risk, and upward pressure on risk premiums. Not every occurrence of this combination leads to a crash. But every historical crash of note has emerged from this climate."