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The guest commentary below was written by Jesse Felder of The Felder Report 

Why The Stock Market Could Be Poised For Another Plunge - 03.02.2020 eject wrecked market cartoon  2

Stocks rallied another 4.5% in May, taking their total gain from the March lows to 39%.

When we put this result into the context of an estimated 52.8% annualized decline in GDP during the current quarter (via the Atlanta Fed), equity valuations have just risen to new record highs.

Why The Stock Market Could Be Poised For Another Plunge - Screen Shot 2020 06 01 at 2.36.31 PM

The new reading in the Buffett Yardstick yields a 10-year forecast for equities of -6% per year, including dividends (based on the 80% negative correlation between the two).

Why The Stock Market Could Be Poised For Another Plunge - Screen Shot 2020 06 01 at 4.11.09 PM

As you probably noticed from the chart above, however, returns over the past decade have exceeded this measure’s forecast by several percent per year so it’s certainly possible for the market to avoid such a nasty fate.

The difference between forecast and actual returns can be explained by sentiment (hat tip, Mark Louis via John Hussman). When investors (and consumers) are overly confident, stocks outperform their fundamentals and vice versa.

Why The Stock Market Could Be Poised For Another Plunge - Screen Shot 2020 06 02 at 12.04.58 PM

Now that sentiment has already begun to rapidly deteriorate, it would seem reasonable to expect the excess returns of the past decade to be given back and possibly in short order.

This would mean the S&P 500 Index would have to fall approximately to the 1,750 area, more than 40% below its current price.

EDITOR'S NOTE

This is a Hedgeye Guest Contributor piece written by Jesse Felder and reposted from The Felder Report blog. Felder has been managing money for over 20 years. He began his professional career at Bear, Stearns & Co. and later co-founded a multi-billion-dollar hedge fund firm headquartered in Santa Monica, California. Today he lives in Bend, Oregon and publishes The Felder Report. This piece does not necessarily reflect the opinion of Hedgeye.