Far Beyond Double

My continued impression is that the global equity markets broadly peaked in the second-quarter of 2015, and that the more recent marginal U.S. highs in August were a “throwover” in response to the post-Brexit plunge in global interest rates. High-yield credit is also rolling over, suggesting that the peak of yield-seeking speculation induced by central banks is probably behind us. That’s not to say that central banks will refrain from further attempts to compress yields in response to economic shortfalls. The problem is that even in a world where short-term rates remain compressed, the valuations and prospective long-term returns of risk-sensitive assets are already far outside the bounds that have historically delivered adequate risk-premiums.

The chart below (h/t Jeff Sandene, Lance Roberts) shows the FTSE All-World Index, a capitalization-weighted index of large and mid-cap stocks in developed and developing countries, covering about 95% of global investable equity value. From a cyclical perspective, the action of the global markets this year may prove to be less a continuation of an ongoing bull market than a corrective rally in what is already an ongoing bear market.

From our standpoint, we’re less concerned with the label of “bull” or “bear” market than we are with the classification of the market return/risk profile that we infer at any point in time, based on valuations, market action, and other factors. Presently, the expected market return/risk classification we identify is not only in the lowest quintile, but is among the most severely negative members of that quintile in history. These return/risk profiles are associated with “unpleasant skew” - a tendency toward modest market gains punctuated by near-vertical losses, producing a distribution with a positive “mode” but awfully negative average returns. See Impermanence and Full-Cycle Thinking for a chart of what this distribution looks like.