"The most striking similarity between the 1920s and 1990s bull markets is the notion that traditional measures of stock valuation had become obsolete."
– Edward Chancellor, Devil Take The Hindmost

You know it’s a bubble when you have to edit the Y axis on all of your charts because valuations have broken above every historical peak, and estimated future market returns have fallen beyond the lowest points in history, including 1929.

One of the things to remember about investing is that the higher the price you pay today, for a given stream of future cash flows, the lower the long-term returns you can expect. It’s exactly when past returns are most glorious that future prospects are most dismal.

Still, it’s also clear that if overvaluation alone was enough to drive prices lower, the market could never reach the sort of extreme hypervaluation we saw in 1929 and 2000, nor the dismal long-term prospects those valuations created.

So we have to distinguish between long-term returns, which are driven by valuations, and returns over shorter segments of the market cycle, which are driven by investor psychology.

When investors are inclined toward speculation, they tend to be indiscriminate about it. In market cycles across history (including the most recent one), we’ve find that the most reliable gauge of whether investors are inclined toward “speculation” or “risk-aversion” is the uniformity of market internals across thousands of stocks, industries, sectors, and security-types, including debt securities of varying creditworthiness.

It’s worth repeating that the entire total return of the S&P 500 during the complete market cycle from 2007-2020 occurred during periods when our measures of market internals were uniformly favorable, with T-bills outpacing the S&P 500 with lower risk otherwise. As I’ve detailed extensively, the one thing that made the recent bull market “different” from prior market cycles was that historically-reliable “overvalued, overbought, overbullish” extremes did nothing to contain speculation amid the novelty of zero interest rate policy. In 2017, we abandoned our willingness to pre-emptively adopt a bearish outlook in response to these syndromes if our measures of internals are still favorable.