Universal Capitulation and No Margin of Safety

The 1929 boom was, in fact, quite a narrow and selective one. It was a boom of the handful of stocks that figured in the daily calculation of the Dow Jones and New York Times indices, and that was why those well-publicized indexes were at record highs. It was also a boom of the most actively traded stocks bearing the names of the most celebrated companies, the stocks mentioned daily by the newspapers and millions of times by the board room habitués – and that was why it was constantly talked about. But it was emphatically not a boom of secondary stocks in which perhaps as many investors were interested.

– John Brooks, Once in Golconda, 1969

The Nifty Fifty appeared to rise up from the ocean; it was as though all of the U.S. but Nebraska had sunk into the sea. The two-tier market really consisted of one tier and a lot of rubble down below. What held the Nifty Fifty up? The same thing that held up tulip-bulb prices long ago in Holland – popular delusions and the madness of crowds. The delusion was that these companies were so good that it didn’t matter what you paid for them; their inexorable growth would bail you out.

– Forbes Magazine, 1977, The Nifty Fifty Revisited

The market is in a two-tier frenzy between the ‘new economy’ stocks and the ‘old economy’ stocks. Anyone who has studied the concept-stock mania of 1968-69, or the ‘Nifty Fifty’ mania of 1972 has to be getting chills here. We’ve seen two-tiered markets before: most prominently in 1929, 1968-69, and 1972. The inconvenient fact is that valuation ultimately matters. That has led to the rather peculiar risk projections that have appeared in this letter in recent months. Trend uniformity helps to postpone that reality, but in the end, there it is. Given current conditions, it is increasingly likely that valuations will begin to matter with a vengeance.

– John P. Hussman, Ph.D., March 7, 2000

Based on the valuation measures we find best-correlated with actual subsequent S&P 500 total returns across a century of market cycles, the stock market presently stands at valuation extremes matched only twice in U.S. financial history: the week ended December 31, 2021 (the 2022 peak occurred the next trading day) and the bubble peak in the week ended August 26, 1929. While our investment discipline is to align our outlook with prevailing, observable market conditions, my impression is that investors are presently enjoying the double-top of the most extreme speculative bubble in U.S. financial history.

Present valuation extremes might only be a long-term concern if our measures of market internals were not also divergent and unfavorable here. It seems popular to imagine that “this time is different” – that the economy has entered a new era of permanently high profit margins and credit expansion; that a narrow, selective, two-tier frenzy among large capitalization glamour stocks is enough to carry the market ever higher. History is not friendly to these ideas, but no forecasts are required. Our outlook will change as observable conditions change.

This month’s comment offers an expansive and data-rich dive into profit margins and market composition. The objective is not to argue, or convince, or urge investors to do anything. We share our research, and we ask nothing in return. Still, if there is one suggestion that might be useful to investors here, it is simply to allow the possibility that market conditions will change. Whether your outlook is bullish or bearish, the notion that the current situation is permanent is exactly what will make you suffer.