Hussman: Overvalued Stocks In for a Painful Correction

Wednesday, 21 Apr 2010 10:34 AM

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Economist John Hussman says stocks are seriously overvalued and that they are poised for a painful correction.

Hussman says that, at current valuations, the S&P 500 is priced to deliver a total return of only about 5.7 percent annually over the coming decade.

But, because stocks are seriously overvalued now, returns will probably be 2.97 percent once the market corrects itself.

"Wholly on the basis of current valuations, stocks are priced to deliver unsatisfactory returns in the coming years — a situation that is worsened by strenuous overbought conditions and upward yield pressures here," Hussman writes in a note to investors.

“This outcome is not dependent on whether or not we observe a second set of credit strains, but is instead baked into the cake as a predictable result of prevailing valuations. The risk of further credit strains simply adds an additional layer of concern here.”

Investors, Hussman notes, have chased risky securities during the past year to the point where the risk premium for default risk has eroded to the levels at the peak of the credit bubble in 2007.

“My sense is that this is a mistake that will be painfully corrected,” Hussman notes.

“Investors now rely on a sustained economic recovery and the absence of any additional credit strains — and even then would be likely to achieve only tepid long-term returns from these levels.”

At today's level, about 1,210 on the S&P, stocks are trading at a cyclically adjusted price/earnings ratio that’s about 30 above the long-term average, says Business Insider CEO Henry Blodgett.

“We've just descended from the longest period of extreme overvaluation in history, suggesting … that the next multi-decade cycle is likely to be below average,” Blodgett says.

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