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There’s Nothing Average About This Stock Market

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In analyzing trends, most people tend to focus on averages. But when it comes to stock and bond markets, the averages don’t really mean a whole lot. These markets spend most of their time far above or below the mean. This has led Dan Kurz of DK Analytics to say stock and bond markets are “reversion beyond the mean machines.

In other words, when markets climb really high above the average, as they have in recent years, they eventually tend to crash to extreme lows far below the average.

Consider the chart above. How often is the P/E at 15.68 average? Rarely. In fact, it is usually significantly higher or significantly lower.

As Kruz says, this is precisely the point.

Currently, we are at a historically elevated valuation (P/E). In fact, we’ve been at historically elevated valuations, which have been getting more elevated, on balance, for most of the past three decades! This is thanks mainly to a globally unprecedented, massive 36-year bull market in bonds, which has resulted in record low interest rates. Stock market manias — valuations divorced from constructive returns, inflation protection, and capital preservation ‘prospects’ — are the progeny of a protracted decline in benchmark interest rates. Manias have surprisingly little to do with the vigor of either GDP growth or EPS growth. Upshot: speculators are ‘hanging their hats’ on sustained low interest rates despite ‘declining prospects.'”

This is yet another indication that markets are currently in giant bubbles.

As we reported last week, even the government has taken notice, acknowledging asset prices are floating in dangerous bubble territory. According to Office of Financial Research analysis, market risk is flashing red, with stock market valuations at historic highs based on several metrics.

Market risks from a sharp change in the prices of assets in financial markets are high and rising. Rising prices and falling risk premiums may leave some markets vulnerable to big changes. Risk premiums are returns in excess of returns on risk-free investments.”

When you consider the historical trends, this huge peak in market valuation will likely be followed by an equally big trough. And yet, despite all of the warnings and virtually everybody acknowledging market valuations are in bubble land, investors keep pouring money into these bloated markets.

Kurz digs into the weeds and shows why now is not the time to be sinking money into stocks.

When are return prospects for stocks best? (And remember, stocks and bonds ‘travel together’) The short answer: when P/E valuations are modest, and both stock earnings yields (E/Ps) and bond yields are high. In other words, not currently.

You can read Kurz’s complete analysis here. He includes a number of graphs to make his case. When you see it laid out, it’s hard to avoid the conclusion that it may well be time to consider moving money into more stable assets such as gold and silver.

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