Currently, the investment landscape presents a challenging environment for long-term equity investors, as articulated by Jon Wolfenbarger. He underscores the notion that prevailing market valuations are at historically high levels, which significantly influences return expectations over the next decade.
Research from Bank of America supports this view, indicating that valuation levels are pivotal in forecasting 80% of the market's returns over a 10-year span.
Wolfenbarger, the visionary behind BullAndBearProfits.com and an esteemed alumnus of JPMorgan and Merrill Lynch, leverages John Hussman's unique valuation metric: the ratio of the market capitalization of all non-financial stocks to their gross value added. Hussman champions this ratio as a premier forecaster of future market performance, which currently anticipates an average annual return of -5% over the coming 12 years.
Other valuation metrics echo this sentiment of heightened market valuations. The Warren Buffett indicator, comparing total market capitalization to GDP, now surpasses levels observed during the dot-com era, nearing its peak in 2022. Similarly, the Shiller cyclically-adjusted price-to-earnings ratio stands above the figures seen in 1929, trailing only behind the peaks of 1999 and 2021.
Wolfenbarger predicts a prolonged market downturn, where the S&P 500 could retract by 50% to 70% from its peak. Historical precedents validate such a correction; post-dot-com bubble and during the Great Financial Crisis, markets experienced significant declines over extended periods.
The catalyst for such a downturn, according to Wolfenbarger, would likely be a softening labor market leading into a recession. He highlights several indicators signaling potential increases in unemployment: a surge in the National Federation of Independent Business' hiring plans index, a decline in The Conference Board's Employment Trends Index, a rise in states reporting increased unemployment rates, and historical patterns following the inversion of the US Treasury yield curve.
Despite an uptick in the unemployment rate from 3.4% in April 2023 to 3.9% by February, the broader economic indicators suggest a looming recession, as per the Sahm Rule. This rule has reliably identified downturns by tracking significant rises in the unemployment rate.
Wolfenbarger's perspective, while more bearish than many of his contemporaries, aligns with other notable market skeptics like Jeremy Grantham and John Hussman, who maintain a cautious stance on market valuations and potential downturns. However, it contrasts with more optimistic forecasts from leading financial institutions, which have recently adjusted their market expectations upwards.
Amidst these diverging views, Pantheon Macroeconomics' Ian Shepherdson points to emerging signs of economic slowdown and labor market weakening, potentially validating Wolfenbarger's cautious outlook. The evolving economic data and market trends will ultimately test the accuracy of these varied predictions, underscoring the complex and unpredictable nature of financial markets.
