There’s really no point in trying to convert anyone to our viewpoint. Somebody will have to hold stocks over the completion of the present cycle, and encouraging one investor to reduce risk simply means that someone else will have to bear it instead.
But for those who understand the narrative of the recent half-cycle, where our challenges have been, and how we’ve addressed them, I do encourage reviewing all risk exposures from the standpoint of the losses that have repeatedly occurred over the completion of market cycles that have reached valuations anywhere near current levels (1929, 1972, 1987, 2000, and 2007). The point is not to discourage stock holdings entirely, but rather to ensure that exposure is not so large that a steep market loss would be intolerable. It’s important to recognize that the market is not only at a point where unusually rich valuations are already in place, but also where market internals and our measures of trend uniformity have clearly deteriorated. This is the most hostile set of market conditions we identify, and it closely overlaps periods in which the stock market has been vulnerable to abrupt air-pockets, free-falls, and crashes.
As I did in 2000 and 2007, I feel obligated to state an expectation that only seems like a bizarre assertion because the financial memory is just as short as the popular understanding of valuation is superficial: I view the stock market as likely to lose more than half of its value from its recent high to its ultimate low in this market cycle.
At present, however, market conditions couple valuations that are more than double pre-bubble norms (on historically reliable measures) with clear deterioration in market internals and our measures of trend uniformity. None of these factors provide support for the market here. In my view, speculators are dancing without a floor.
A final note: There is a danger in ignoring the concerns of value-conscious investors as a bubble proceeds. The danger is that the longer these concerns are “proven wrong” by further advances, the more severely they are likely to be proven correct by an even deeper loss over the completion of the cycle. Roger Babson offers a useful lesson in that regard. Babson, whose first rule of investing was to “keep speculation and investments separate,” is known not only for founding Babson College in Massachusetts, but also for a speech at the National Business Conference on September 5, 1929, at the peak of the market, saying “sooner or later a crash is coming, and it may be terrific.”