Most overvalued EVER

We are currently the most over valued the US stock markets have ever been according to methodology designed by John Hussman.


I also found his comments on log periodic power laws so in tune to the current market we are in. While I don’t have any idea when the impending top will be in, I certainly feel like the TOP is here every day.  Of one thing I am absolutely sure of is that nobody expects it. We have become so used to elevating markets that we don’t even remember what market uncertainty is. There have been so many records of overzealous investment behaviour over the last few years that we don’t even notice how one sided we have become.

For now us market bears are an embarrassment, we are looneys, we have lost touch of the obvious. Whilst I will argue that most of us are ultimate rationalists I would say it is interesting to note how it is quite possible to be rational within a bubble as eloquently described below.

The last week or two I started thinking to myself if my knowledge that I have accumulated over the last 25 yrs of business and investing is even relevant anymore. But a few days later I feel more empowered than ever.

On the accelerating slope of the current advance

Speaking of Didier Sornette, I’ve periodically discussed his concept of “log periodic power-law” price behavior, which has accompanied speculative episodes in numerous markets and often precedes inflection points or collapses. This structure is based on a purely mathematical fit to price behavior, and does not reflect any valuation considerations. It’s not part of our own investment discipline, but we occasionally fit the log-periodic structure to price behavior when market movements are particularly extreme.

In recent years, those structures have generally identified inflection points of flat or correcting prices, but certainly not crashes in the S&P 500. Given the increasingly steep slope of the current market advance, along with the most extreme valuations in history and the most lopsided bullish sentiment in more than three decades, it’s quite possible that this instance will be different. In any event, the underlying “arbitrage” considerations described by Sornette are worth reviewing here.

In 2000, as the tech bubble was peaking, Nobel laureate Franco Modigliani observed that the late stages of a bubble can be “rational” in a certain sense, provided that investors are inclined to self-reinforcing behavior.

Imagine a market that you fully believe to be overvalued and at risk of a market crash. Indeed, let’s say that there is a defined probability of a crash, which increases rapidly as the pitch of the market advance becomes more extreme. Should you sell? Well, it depends. Given that an immediate crash is not certain, a speculator must, in each period, weigh the potential gain from holding a bit longer against the potential loss from overstaying. Sornette uses a similar argument to describe a speculative bubble advancing toward its peak (italics mine):

“Since the crash is not a certain deterministic outcome of the bubble, it remains rational for investors to remain in the market provided they are compensated by a higher rate of growth of the bubble for taking the risk of a crash, because there is a finite probability of ‘landing smoothly,’ that is, of attaining the end of the bubble without crash.”

“This line of reasoning provides us with the following important result: the market return from today to tomorrow is proportional to the crash hazard rate. In essence, investors must be compensated by a higher return in order to be induced to hold an asset that might crash. As the price variation speeds up, the no-arbitrage conditions, together with rational expectations, then imply that there must be an underlying risk, not yet revealed in the price dynamics, which justifies this apparent free ride and free lunch. The fundamental logic here is that the no-arbitrage condition, together with rational expectations, automatically implies a dramatic increase of a risk looming ahead each time the price appreciates significantly, such as in a speculative frenzy or in a bubble. This is the conclusion that rational traders will reach.”

The chart below shows our current best-fit parameterization of Sornette’s log-periodic structure, applied to the S&P 500 Index. Notably, unless we allow for the slope of the current market advance to become quite literally infinite, it’s impossible to closely fit the current price advance without setting the “finite-time singularity” – the point at which instability typically emerges – within a few days of the present date. Notably, the singularity is not the date of a crash. Rather, it’s the point where the pitch of the advance reaches an extreme, which may simply be an inflection point (as has been the case for other structures in recent years) or a pre-crash peak.

Hussman Estimate of Sornette Log-Periodic Bubble - February 2018

The collapse is fundamentally due to the unstable position; the instantaneous cause of the crash is secondary.
– Didier Sornette

If you want my opinion (which we don’t trade on and neither should you), my opinion is that this singularity will prove to be more than an inflection point. Though nearly every morning prompts the phrase “Yup, they’re actually going to do this again,” the steepening pitch of this ascent – coupled with record valuation extremes, record overbought extremes, and the most lopsided bullish sentiment in over three decades – now produces the most extreme “overvalued, overbought, overbullish” moment in history. In prior cycles across history, similar syndromes were either joined or quickly followed by deterioration in market internals. In this cycle, it has been essential to wait for explicit deterioration in market internals before establishing a negative outlook. Notably, the market has lost value, even since 2009, when overvalued, overbought, overbullish conditions were joined by divergent internals.

I expect the S&P 500 to lose approximately two-thirds of its value over the completion of this cycle. My impression is that future generations will look back on this moment and say “… and this is where they completely lost their minds.” As I’ve regularly noted in recent months, our immediate outlook is essentially flat neutral for practical purposes, though we’re partial to a layer of tail-risk hedges, such as out-of-the-money index put options, given that a market decline on the order of even 5% would almost certainly be sufficient to send our measures of market internals into a negative condition. It’s best not to rely on the ability to execute sales into a falling market, because the range-expansion we’ve recently seen on the upside may very well have a mirror-image on the downside. As usual, we’ll respond to new evidence as it emerges.

Embarrassing but …

My last post on this site spoke of shorting the Crypto Bitcoin at around 7000, believing then like I do now that we are in a bubble.

This call comes on the back of repeated calls that the bull market in the US major indexes was due a major correction for the past couple of years. In short I have been hopelessly wrong on all my market calls but I will still say that I believe I am correct when highlighting that the markets have moved very far away from fair value which to me is a really good reason for not wanting to invest in something.

I think I need to also learn from this experience that being a value investor is probably an acceptable way of investing long only, but including the short side to take aggressive advantage of what I believe to be over-valued has proven to me once again that this is seriously dangerous, especially if you are going to base your investments to an ideology with religious zeal.

I have learned some lessons…….

The markets are a consistent replay of the past, hidden beneath many disguises. They all however lead back to the same story.

Why I am writing this post now is because I am feeling sick and tired of seeing the easy money some people are making now in the crypto currencies and their offshoots the ICO.  I am seeing many idiots (maybe I am the idiot) with no financial experience become the oracles of sensible new age investing with these crypto’s. As I watch more and more people become wealthy beyond their wildest imaginations I become more dispirited but feel helpless as there is nothing I can do about it. I cannot join this party as doing so for me would be making a far greater cardinal sin, i.e. joining the madness. It would be far worse for me to succumb to this irrational behaviour and then fall prey to its lessons. I know there is madness, the madness of crowds playing its part in this current play of human greed. However, I am forced to resign myself to watching the show play out as I know and understand it will from my studies of centuries of economic history.

After all the studying, reading the excesses from a far, removed from the emotional grip of the moment I am less prepared than I thought I would be. I have witnessed probably 3 market mania’s in my lifetime, and in all I have been on the opposing side. The contrarian fighting the mania. This is the first time I have wished to be a part of the mania to some degree. To have seen it and capitalised on it, riding the wave beyond the limits of which I am usually comfortable. But alas I find myself the outsider.

I have come to see myself as quite the fundamentalist in my approach to certain theories of the mind. On the one hand I want to call my behaviour, sloppy. Maybe even lazy. Not willing to see the other side as much as I should be willing.

I feel the need to digress a moment. There is indeed something about my personality that makes me a purest. An idealist. A careless romantic to the belief that in the end stability and equilibrium prevail. I am so resolute and committed to some of these notions that often accepting a greyer more watered down version of these views seems to me a disloyal betrayal to what I hold sacrasanct.

In conclusion I believe I am going to be once again correct, but I believe there are lessons to learn. I believe I place to much identify with being a purest, thrusting my wishes for a world to be more equitable on the markets and believing that unfair excesses are to be slammed, shamed, called to book. Instead of embracing that in a world that displays long term equilibrium it is completely disinterested in equity. In meritocracy.  I believe I hold to dear this notion of no free lunch. That this is not possible, or if it is possible that it will come with punishment to those enjoying the freebie.

The markets will behave exactly in this manner for a period of time as markets do not trade in equilibrium most of the time. Rather equality is the anchor which they seek but extreme is the order of the day and the mechanism for its discovery.

In short I need to distant some of my emotions that believe it is wrong to capitalise on inequality, inequity. I believe I am not accepting part of my own shadow that wants to be a party to this orgy of excess.

Lets hope I can write more in 2018 as I have so many more thoughts and ideas I wish to share with myself this year. Indeed going deeper and exploring this shadow might become one of the most profitable growth chapters of my life. Lets go deep…….