These 8 Measures Say A Crash Is Coming – But When?

The stock market’s return over the next decade is likely to be well below historical norms.

The original article has been edited here by munKNEE.com for length (…) and clarity ([ ])

So says Mark Hulbert in a recently penned article discussing the “Eight Best Predictors Of The Stock Market” …as outlined below:

Hubert said:

“To illustrate the bearish story told by each of the above indicators, consider the projected 10-year returns to which these indicators’ current levels translate.

• The most bearish projection of any of them was that the S&P 500 would produce a 10-year total return of 3.9 percentage points annualized below inflation. The most bullish was 3.6 points above inflation.
• The most accurate of the indicators I studied was created by the anonymous author of the blog Philosophical Economics. It is now as bearish as it was right before the 2008 financial crisis, projecting an inflation-adjusted S&P 500 total return of just 0.8 percentage point above inflation. Ten-year Treasuries can promise you that return with far less risk.”

According to various tests of statistical significance, each of these indicators’ track records is significant at the 95% confidence level that statisticians often use when assessing whether a pattern is genuine…“

The chart below, courtesy of Michael Lebowitz, shows the standard deviation from the long-term mean of the “Buffett Indicator,” or market capitalization to GDP, Tobin’s Q, and Shiller’s CAPE compared to forward real total returns over the next 10-years…

Let me explain what “low forward returns” does and does not mean.

• It does NOT mean the stock market will have annual rates of return of sub-3% each year over the next 10-years.
• It DOES mean the stock market will have stellar gains in some years, a big crash somewhere in between, or several smaller ones, and the average return over the decade will be low. 

This is shown in the table and chart below which compares a 7% annual return (as often promised) to a series of positive returns with a loss, or two, along the way. (Note: the annual average return without the crashes is 7% annually also.)

From current valuation levels, two-percent forward rates of return are a real possibility. As shown, all it takes is a correction, or crash, along the way to make it a reality.

The problem with using valuation measures, as Mark Hulbert discusses, is that there can be a long period between a valuation warning and a market correction. This was a point made by Eddy Elfenbein from Crossing Wall Street, who said:

• “For the record, I’m a bit skeptical of these metrics. Sure, they’re interesting to look at, but I try to place them within a larger framework.
• It’s not terribly hard to find a measure that shows an overvalued market and then use a long time period to show the market has performed below average during your defined overvalued period. That’s easy. The difficulty is in timing the market.
• Even if you know the market is overpriced, that doesn’t tell you much about how to invest today.”

He is correct so, if valuation measures tell you a problem is coming, but don’t tell you what to do, then Wall Street’s answer is simply to “do nothing.” After all, you will eventually recover the losses….right?