Financial bubbles are built on the notion that a speculator can buy an asset now and find “a greater fool” who will be willing to pay more for it later.
Central banks like the Federal Reserve are nursing this idea with asset purchases that have created the third major bubble in the past 16 years, John Hussman, president of Hussman Investment Trust, says in a weekly commentary that discusses the limits of monetary policy on markets.
Stock-market benchmarks such as the S&P 500 and the New York Stock Exchange Composite Index are showing signs of weakness, he says. The S&P 500 is about 3 percent higher than it was in December 2014, while the broader NYSE composite hasn’t set a record in more than two years.
“Over the past two years, the behavior of the stock market can be described less as an ongoing bull market than as the extended topping phase of what is now the third financial bubble since 2000,” Hussman says. “We continue to classify present conditions within the most hostile expected market return/risk profile we identify.”
He cites numerous metrics that demonstrate how expensive stocks are in relation to the profitability of public companies. Market gains are increasingly dependent on a shrinking number of stocks, raising the risk that a single company can move market benchmarks.
“While the bubble peak in 2000 was the most extreme level of valuation in history on a capitalization-weighted basis, the recent speculative episode has actually exceeded that bubble from the standpoint of speculation in individual stocks,” Hussman says. “Presently, the median stock in the S&P 500 is more overvalued than at any point in U.S. history, easily exceeding the overvaluation observed at the 2000 and 2007 pre-crash extremes.”
Central banks are adding to the risk by flooding the financial system with credit that encourages investors to overpay for assets.
“The danger is that investors seem to believe that easy money supports overvalued financial markets regardless of market internals or the attitude of investors toward risk,” Hussman says. “The failure of investors to grasp this critical subtlety is likely to be the source of a great deal of pain over the completion of this market cycle.”
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