Stock Market Forecast = Marine Layer

Living in Los Angeles I’ve often woken up in the morning to see a big grey haze out everywhere (like today) that people affectionately refer to as the marine layer.  Eventually it usually “burns off” by the afternoon, sometimes by 10 am, sometimes 2pm, sometimes not at all.

That pattern reminds me a bit of where we are with stock market valuations.  As the good Dr. Hussman shows in his weekly blog, it doesn’t really matter which market valuation metric you prefer, most signal a bit of overvaluation to the market.  It’s nothing nearly as awful as the late 1990s, but it means that until this valuation “burns off”, which can take years, decades, or possibly even a month or two, you will have somewhat muted returns of perhaps 4% nominal per year.  Below are his charts that look at some basic valuation metrics and subsequent market returns.

This is also a reason we prefer using these valuation metrics not only as an absolute indicator, but also relative.  Usually, there is some country trading at low valuations (Greece, Ireland) while others are trading at rich ones (Columbia, US).  We examined constructing trading models out of global valuation metrics in our paper Global Value: Building Trading Models with the 10 Year CAPE.

Here is also a nice piece on stock market indicators we sent out to the Idea Farm list this weekend.