31st August 2016

Our proprietary metrics indicate that the US and Australian share markets are very expensive at present. Although we are confident of the sound statistical basis of our metrics, it is reassuring to know that we are in good company: in recent months several very successful global investors have warned that US equities are over-priced, or have stated very clearly that they have taken out portfolio protection. For example:

  • Legendary hedge fund managers George Soros and Paul Tudor Jones have both increased their short positions on the S&P500.
  • Carl Icahn said in June, “I don’t think you can have zero interest rates for much longer without having these bubbles explode on you.”
  • In late July Jeff Gundlach, founder of DoubleLine, said, “Sell everything. Nothing here looks good.”
  • Only this month Paul Singer, who manages USD$28 billion, warned that “the ultimate breakdown (or series of breakdowns) from this environment is likely to be surprising, sudden, intense, and large.”

As the chart below show, the price-to-earnings ratio of the SP&500 has now climbed back to its highest level since the GFC, and is approaching the peak it reached in 2000 during the dotcom boom.


The extent of the over-valuation means that a dramatic pickup in the US economy would be necessary before the S&P500 could become fair value. With June quarter GDP growth of only 1.1%, a sharp recovery is unlikely in the near future. As the chart below shows, earnings and revenue have been falling for the last four quarters.


The over-valuation is not limited to US equities. The bond market is so expensive that USD$13 trillion worth of bonds now trade on negative yields – that is, holding these bonds to maturity will bring a guaranteed loss. Every month, the respected fund manager GMO publishes its forecast of asset class returns in USD over the next seven years, assuming 2.2% inflation. The latest forecast, shown below, predicts negative returns for almost all asset classes.


Under these conditions, a correction is highly likely. In accordance with our focus on capital preservation, Arminius has retained the bulk of the portfolio in cash and has bought put options on the S&P500. This is one of those times in the market when we focus on the return of capital instead of the return on capital.