Experts Begin Citing Overvalued Markets

The last several years have provided phenomenal returns for equity investors. Since the market bottom in 2009, the Dow Jones Industrial Average is up almost 150% and the S&P 500 is near all-time highs. We have written in previous articles regarding overvaluation in the markets (specifically in the technology industry) and the concerns that a 5 year bull market with no substantial correction raises. As the markets continue to go on a tear, more experts are beginning to cite the same fears that we have noted in recent months.

Dr. John Hussman is a portfolio manager that we enjoy reading for his thoughts on the markets and investing. In his most recent piece, “It is Informed Optimism to Wait for the Rain,” Hussman dives into market returns and predictions for equities going forward.

Hussman touches on the fact that investors are chasing yields in the markets as opportunities have become scare across sectors. He cites low interest rate policies of the Federal Reserve following the tech bubble burst as the catalyst for investors to search for yield in the housing market. The demand for mortgage backed securities, spurred by the incorrect notion that housing prices could never decline, skyrocketed, and underwriters were forced to meet demand by increasing supply with mortgage backed securities backed by poor quality loans. That in turn paved the way for the 2008 Credit Crisis. Today, investors continue to search for yield in a low interest rate environment.

5 years after the market bottom, the Dow Jones and S&P 500 have fully recovered, but the policies have not changed, and low interest rates could very easily usher in another market decline.

Hussman also points out that identifying a market top can be a tedious and difficult task. When looking at a long term chart, market peaks seem as if they were an instantaneous event. In reality, market peaks take time to develop, and can be difficult to identify.

It is imperative for investors to understand the basics of market behavior. Markets always cycle; there will be periods of growth and periods of contraction in the short, mid and long term. While a buy and hold strategy is not always the answer, and likely will be a problem for investors seeking returns over the next several years, investors need to understand the difference between speculating and investing. Unfortunately, more often than not, individuals speculate rather than invest.

Dr. Hussman’s article reaffirms what we have been saying for months; the markets simply cannot support their current valuations, and in our opinion could be due for a pullback. We do not believe that this will be a brief 10% correction like we saw in 2011, but rather a more severe sell off. Assuming equities will continue seeing double digit returns forever is like assuming your home will never drop in value…and we all witnessed how that notion panned out.

Ben Treece is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and licensed with FINRA (www.Finra.org) through Treece Financial Services Corp. The above information is the opinion of Ben Treece and should not be construed as investment advice or used without outside verification.
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