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Hussman finds another metric to back up bear case

Bearish folks think tech companies, by paying dividends, are signalling that they have no “better” use for the cash. However, in some cases, companies that kept all their cash often misspent it on unprofitable initiatives or ill-conceived acquisitions. A polar bear growls at the St. Felicien Wildlife Zoo in St. Felicien, March 5, 2009

MATHIEU BELANGER/REUTERS

From the doom and gloom aisle in the financial supermarket, here are some noteworthy factoids from U.S. fund manager John Hussman and his latest missive to clients.

Citing work by Ned Davis Research, Mr. Hussman has doubled down on his call that the U.S. stock market is overvalued and ripe for a steep fall.

The usual way to assess whether the market is too pricey is to look at conventional metrics, such as price earnings ratios or dividend yields, and compare them to past values. Another approach is to look at the total worth of all the stocks on the market, compared to the size of the economy.

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It's a pretty elegant way of determining whether stocks are expensive or cheap, relative to historical valuations and the output of an economy, which after all is what supports the market.

Currently, stock market capitalization as a share of GDP is 105 per cent. The historical average is only about 60 per cent, and even worse, at 50 per cent if you exclude the wild period of frothy markets since the mid 1990s. In other words, stocks are about twice as pricey as their average historial level, when measured against the economy.

For those on market crash alert, the current valuation by this metric is higher than the 86 per cent just before the 1929 start of the Great Depression and the 80 per cent level prevailing before the steep 1973-74 market tumble.

"Presently, market cap is elevated because stocks seem reasonable as a multiple of recent earnings, but earnings themselves are at the highest share of GDP in history. Valuations are wicked once you normalize for profit margins. Given that stocks are very, very long-lived assets, it is the long-term stream of cash flows that matters most – not just next year's earnings. Stock valuations are not depressed as a share of the economy. Rather, they are elevated because they assume that the highest profit margins in history will be sustained indefinitely," Mr. Hussman writes.

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About the Author
Investment Reporter

Martin Mittelstaedt has had a varied reporting career at the Globe and Mail, covering politics, the environment and business. He opened up the Globe's New York bureau for the Report on Business, and has also been on the banking and capital markets beats. He's written extensively on investing themes. More

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