Warren Buffett, the CEO of Berkshire Hathaway and perhaps the most successful investor alive today, advises us to “be fearful when others are greedy and greedy when others are fearful.”
Following that advice today is surprisingly difficult. With the stock market hitting successive all-time highs, the last thing we want is to consider leaving the party.
But just because it’s difficult doesn’t mean it’s unimportant. So in this column I’m reviewing some of the most commonly-cited reasons to be fearful, based on a review of the select few bears among the nearly 200 investment newsletters I monitor.
One of their biggest longer-term worries is stocks’ extreme overvaluation. Take the so-called Shiller P/E ratio, named for Yale University economics professor and Nobel laureate Robert Shiller. His indicator takes the traditional price-to-earnings ratio and, instead of focusing on 12-month earnings, uses ten-year average inflation-adjusted earnings.
Yale University professor Robert Shiller, a winner of the Nobel Memorial Prize in Economic Science.
Shiller’s P/E is higher than at any time over the last 140 years, with just two exceptions: the years leading up to the 1929 stock market crash and prior to the bursting of the internet bubble in early 2000. Those are ominous precedents, needless to say.
It would be one thing if the market’s overvaluation were occurring when the economy was firing on all cylinders, but many of the bears believe it’s anything but.
Barry Rosen, editor of Fortucast Commodity Market Timers, asserts that the allegedly low current unemployment rate in this country is “phony,” given the nearly 100 million potential workers who have simply given up even looking. To make matters worse, Rosen continues, “politicians have continued to play games borrowing money and printing money rather than making the real economy work.”
To be sure, severe overvaluation doesn’t necessarily mean the market will immediately decline. The Shiller P/E ratio was just as high as it is now in March 1997, for example, and yet the bull market continued for three more years.
Eventually, though, valuation wins out, according to many of the bears. To make this point, Ben Inker, co-head of the asset-allocation team at Boston-based money management firm GMO, often uses an analogy of a leaf in a hurricane. “You have no idea where the leaf will be a minute or an hour from now,” he says. “But eventually gravity will win out and it will land on the ground.”
For shorter-term forecasts, the bears I monitor focus on a number of indicators of the market’s internal health. A healthy market is one in which the vast majority of stocks are rising together, while it’s an early warning signal of trouble when fewer and fewer participate.
Many bears are seeing disturbing signs of these early warning signals, sometimes referred to as divergences. Fari Hamzei, founder of Hamzei Analytics, said in an email that he has been detecting potentially serious divergences for a year now. To be sure, “so far [they] have resulted in false positives, but as we go higher in price and forward in time, if history is any guide, we should see a watershed moment.”
Dennis Gartman, editor of the institutional service The Gartman Letter, is worried that the Federal Reserve will unwittingly push the economy into a recession, which would in turn be bad for stocks. In an interview, he told me that far more often than not in the past when the Fed has begun to raise interest rates, it has at some point raised them too far and too fast. “They will probably do so again,” he says. Given that the stock market is so overvalued, there is little room for error: “Ownership of equities is ill advised.”
Needless to say, the bullish advisers I follow aren’t persuaded by these or any of the other bear arguments, convinced that there are good counters to each of them.
But if you have been bullish on the assumption that a good case can’t be made for being bearish, you might want to rethink your optimism.
Mark Hulbert, founder of the Hulbert Financial Digest, has been tracking investment advisers’ performances for four decades. For more information, email him at firstname.lastname@example.org or go to www.hulbertratings.com.
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