Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
FED Balance Sheet Current State - 5th Mar 21
The Global Vaccine Race Against Time and Variants - 5th Mar 21
US Treasury Yields Rally May Trigger A Crazy Ivan Event (Again) In Stock Market - 5th Mar 21
After Gold’s Slide, What Happens to Miners? - 5th Mar 21
Racism Pandemic Why UK Black and Asians NOT Getting Vaccinated - NHS Covid-19 BAME - 5th Mar 21
Get Ready for Inflation Mega-trend to Surge 2021 - 4th Mar 21
Stocks, Gold – Rebound or Dead Cat Bounce? - 4th Mar 21
The Top Technologies That Are Transforming the Casino Industry - 4th Mar 21
How to Get RICH Crypto Mining Bitcoin, Ethereum With NiceHash - 4th Mar 21
Coronavirus Pandemic Vaccines Indicator Current State - 3rd Mar 21
AI Tech Stocks Investing 2021 Buy Ratings, Levels and Valuations Explained - 3rd Mar 21
Stock Market Bull Trend in Jeopardy - 3rd Mar 21
New Global Reserve Currency? - 3rd Mar 21
Gold To Monetary Base Ratio Says No Hyperinflation - 3rd Mar 21
US Fed Grilled about Its Unsound Currency, Digital Currency Schemes - 3rd Mar 21
The Case Against Inflation - 3rd Mar 21
How to Start Crypto Mining Bitcoins, Ethereum with Your Desktop PC, Laptop with NiceHash - 3rd Mar 21
AI Tech Stocks Investing Portfolio Buying Levels and Valuations 2021 Explained - 2nd Mar 21
There’s A “Chip” Shortage: And TSMC Holds All The Cards - 2nd Mar 21
Why now might be a good time to buy gold and gold juniors - 2nd Mar 21
Silver Is Close To Something Big - 2nd Mar 21
Bitcoin: Let's Put 2 Heart-Pounding Price Drops into Perspective - 2nd Mar 21
Gold Stocks Spring Rally 2021 - 2nd Mar 21
US Housing Market Trend Forecast 2021 - 2nd Mar 21
Covid-19 Vaccinations US House Prices Trend Indicator 2021 - 2nd Mar 21
How blockchain technology will change the online casino - 2nd Mar 21
How Much PC RAM Memory is Good in 2021, 16gb, 32gb or 64gb? - 2nd Mar 21
US Housing Market House Prices Momentum Analysis - 26th Feb 21
FOMC Minutes Disappoint Gold Bulls - 26th Feb 21
Kiss of Life for Gold - 26th Feb 21
Congress May Increase The Moral Hazard Building In The Stock Market - 26th Feb 21
The “Oil Of The Future” Is Set To Soar In 2021 - 26th Feb 21
The Everything Stock Market Rally Continues - 25th Feb 21
Vaccine inequality: A new beginning or another missed opportunity? - 25th Feb 21
What's Next Move For Silver, Gold? Follow US Treasuries and Commodities To Find Out - 25th Feb 21
Warren Buffett Buys a Copper Stock! - 25th Feb 21
Work From Home Inflationary US House Prices BOOM! - 25th Feb 21
Man Takes First Steps Towards Colonising Mars - Nasa Perseverance Rover in Jezero Crater - 25th Feb 21
Musk, Bezos And Cook Are Rushing To Lock In New Lithium Supply - 25th Feb 21
US Debt and Yield Curve (Spread between 2 year and 10 year US bonds) - 24th Feb 21
Should You Buy a Landrover Discovery Sport in 2021? - 24th Feb 21
US Housing Market 2021 and the Inflation Mega-trend - QE4EVER! - 24th Feb 21
M&A Most Commonly Used Software - 24th Feb 21
Is More Stock Market Correction Needed? - 24th Feb 21
VUZE XR Camera 180 3D VR Example Footage Video Image quality - 24th Feb 21
How to Protect Your Positions From A Stock Market Sell-Off Using Options - 24th Feb 21
Why Isn’t Retail Demand for Silver Pushing Up Prices? - 24th Feb 21
2 Stocks That Could Win Big In The Trillion Dollar Battery War - 24th Feb 21
US Economic Trends - GDP, Inflation and Unemployment Impact on House Prices 2021 - 23rd Feb 21
Why the Sky Is Not Falling in Precious Metals - 23rd Feb 21
7 Things Every Businessman Should Know - 23rd Feb 21
For Stocks, has the “Rational Bubble” Popped? - 23rd Feb 21
Will Biden Overheat the Economy and Gold? - 23rd Feb 21
Precious Metals Under Seige? - 23rd Feb 21
US House Prices Trend Forecast Review - 23rd Feb 21
Lithium Prices Soar As Tesla, Apple And Google Fight For Supply - 23rd Feb 21
Stock Markets Discounting Post Covid Economic Boom - 22nd Feb 21
Economics Is Why Vaccination Is So Hard - 22nd Feb 21
Pivotal Session In Stocks Bull Bear Battle - 22nd Feb 21
Gold’s Downtrend: Is This Just the Beginning? - 22nd Feb 21
The Most Exciting Commodities Play Of 2021? - 22nd Feb 21
How to Test NEW and Used GPU, and Benchmark to Make sure it is Working Properly - 22nd Feb 21
US House Prices Vaccinations Indicator - 21st Feb 21
S&P 500 Correction – No Need to Hold Onto Your Hat - 21st Feb 21
Gold Setting Up Major Bottom So Could We See A Breakout Rally Begin Soon? - 21st Feb 21
Owning Real Assets Amid Surreal Financial Markets - 21st Feb 21
Great Investment Ideas For 2021 - 21st Feb 21

Market Oracle FREE Newsletter

FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

Can the Stock Market Get Any Better Than This? Korean Black Swan?

Stock-Markets / Stock Markets 2013 Aug 04, 2013 - 01:13 PM GMT

By: John_Mauldin


What in the world is going on?! As I write this letter from the Maine woods, the S&P 500 has just cleared 1,700 for the first time. The German DAX continues to set all-time highs above 8,400. The United Kingdom’s FTSE 100 is quickly approaching its 1999 record high of 6,930, and its mid-cap cousin, the FTSE 250, just broke through to its all-time level above 15,000. And last but not least, Japan’s Nikkei 225 is extending its gains once more, toward 14,500. This weekend I am sitting around with some of the smartest economic and trading minds in the country. At Leen's Lodge, where we're fishing and eating where our phones don’t work, the question on our minds is, how long can this run go on? The debates can get intense in a room full of strong opinions.

So, with a little help, I did some research on what our forward-looking prospects are for the markets. Let me take this opportunity to introduce a new name to readers, one that will become familiar over the next few years. I have gotten to know Worth Wray, a young economist (though I should say that, as I stare 64 in the face, a lot of people are looking young these days) who has really impressed me with the breadth of his knowledge and insights. He was the former portfolio strategist for my good friends at Salient down in Houston, and they were kind enough to let me entice him to come to Dallas to work with me. This is a big move for both of us, and I am finding that it's one I should have undertaken a long time ago. Worth is really going to help me expand my abilities to do research and present my thoughts to you. I asked him a few questions, and he helped me tee up this week’s letter. Plus, we'll look across the Pacific, and I'll share some though ts I’ve had about an interesting black swan that could be developing in the Korean Peninsula. Let’s get started!

Can It Get Any Better Than This?

To many investors, developed markets appear healthier and stronger than they have in years. Major equity markets are rallying to record highs; corporate credit spreads are tight versus US Treasuries and getting tighter; and broad measures of volatility continue to fall to their lowest levels since 2007.

This kind of news would normally point to prosperity across the real economy and call for a celebration – but prices do not always reflect reality. Moreover, the combination of high and rising valuations, low volatility, and a weakening trend in real earnings growth is a proven recipe for poor long-term returns and market instability.

Let’s take the S&P 500 as an example. It returned roughly 42% from September 1, 2011, through August 1, 2013, as the VIX Index fell to its lowest levels since the global financial crisis. Over that time frame, real earnings declined slightly (down about 2% through Q1 2013 earnings season), while the trailing 12-month price-to-earnings (P/E) ratio jumped 44%, from 13.5x to 19.5x. That means the majority of the recent gains in US equity markets were driven by multiple expansion in spite of negative real earnings growth. This is a clear sign that sentiment, rather than fundamentals, is driving the markets higher.

Of course, the simple trailing 12-month P/E ratio can be misleading at critical turning points if you are trying to handicap the potential for long-term returns. For example, the collapse in real earnings during the global financial crisis sent the S&P 500’s trailing P/E multiple through the roof by March 2009. So, while trailing P/E is a useful tool for understanding what has already happened in the market, the “Shiller P/E” is far more useful for calculating a reasonable range of expected returns going forward. This approach won’t help you much with short-term market timing, but current valuations have historically proven extremely useful in forecasting long-term returns. In his book Irrational Exuberance (2005), Robert Shiller of Yale University shows how this approach “confirms that long-term investors – investors who commit their money to an investment for ten full years – did do well when prices were low rel ative to earnings at the beginning of the ten years. Long-term investors would be well-advised, individually, to lower their exposure to the stock market when it is high … and to get into the market when it is low.”

As you can see in Figure 6, compared to the more common trailing 12-month P/E ratio in Figure 5, the Shiller P/E metric essentially smooths out the series and helps us avoid false signals by dividing the market’s current price by the average inflation-adjusted earnings of the past ten years. Historically, this range has peaked and given way to major market declines at around 29x on average (or 26x excluding the dot-com bubble), and it has bottomed in the mid-single digits. Not only does today’s Shiller P/E of 24x suggest a seriously overvalued market, but the rapid multiple expansion of the last two years in the absence of earnings growth suggests that this market is also seriously overbought.

John Hussman helps us keep current valuations in historical perspective:

The Shiller P/E is now 24.4, about the same level as August 1929, higher than December 1972, higher than August 1987, but less extreme than the level of 43 that was reached in March 2000 (a level that has been followed by more than 13 years of market returns within a fraction of a percent of the return on Treasury bills – and even then only by revisiting significantly overvalued levels today). The Shiller P/E is presently moderately below the level of 27 at the October 2007 market peak. It’s worth noting that the 2000-2001 recession is already out of the Shiller calculation. Moreover, looking closely at the data, the implied profit margin embedded in today’s Shiller P/E is 6.3%, compared with a historical average of only about 5.3%. At normal profit margins, the current Shiller P/E would be 29.

While it may be impossible to accurately predict when this policy-driven market will break, history suggests it would be very reasonable for the secular bear to eventually bottom at a P/E multiple between 5x and 10x, opening up one of the rare wealth-creation opportunities to deploy capital at truly cheap prices. Some of these technical details are rather dry, but I hope you'll focus on the main idea: We are not talking about the potential for a modest 20% to 30% drawdown in the S&P 500. If history is any indication, we are talking about the potential for a 50%+ peak-to-trough drawdown and ten-year average annual returns as bad as -4.4%, according to the chart above from Cliff Asness at AQR. Such a result would fall in line with somewhat similar deleveraging periods such as the United States experienced in the 1930s and Japan has experienced since 1989. There is no way to sugarcoat it: too much equity risk can be unproductive and even destructive in this kind of economic environment.

But where there is danger, there is also opportunity. This is a terrific time to take some profits and diversify away from the growth-oriented risk factors that dominate most investors’ portfolios. Instead of concentrating risk in one asset class or one country, investors can boost returns and achieve more balance by taking a global view, by broadening the mix of core asset classes, and by weighting those return streams to achieve balance across potential economic outcomes (rather than trying to predict the future). Since equities and credit are essentially a directional bet on positive economic growth and benign inflation, you have a lot to gain from diversifying into other core market risks: commodities, which thrive when inflation, or more specifically expected inflation, is rising; and nominal safe-haven government bonds, which thrive as inflation gives way to deflation and the oth er assets typically decline. While each group of asset classes responds to economic conditions differently and exhibits low correlations to the others, each of them tends to offer similar risk-adjusted returns over long periods of time, thus warranting constant inclusion in any core portfolio.

It also makes sense to embrace truly diversifying alternative strategies that are either less correlated or negatively correlated. When valuations are expensive across the board, momentum-based strategies like managed futures can be a fantastic addition to a portfolio. Aside from government bonds, momentum is the only easily accessible strategy that tends to become more negatively correlated with broader markets during times of extreme stress and tends to deliver outsized returns when your other investments are losing money.

Of course, combining the asset classes into one portfolio is the hard part, but research going back to the early 1970s suggests that broadening this mix of core assets – so that you have some element of your portfolio that responds positively to every potential economic season – and managing the relative allocations to each economic scenario may be your biggest opportunity to add value in the investing process.  

You have a lot to gain from diversifying as broadly as possible, eliminating unrewarded costs, reducing your reliance on equity risk, and reining in the emotional mistakes that often lead investors to dramatically underperform. Remember, in a world characterized by deleveraging, changing demographics in aging populations, financial repression, and increasingly experimental monetary policy, every basis point counts and anything can happen.

With that, let’s end our discussion with a few words of advice from the world’s largest and arguably most successful hedge fund manager, Ray Dalio:

What I'm trying to say is that for the average investor, what I would encourage them to do is to understand that there's inflation and growth. It can go higher and lower and to have four different portfolios essentially that make up your entire portfolio that gets you balanced.  Because in every generation, there is some period of time, there's a ruinous asset class, that will destroy wealth and you don't know which one that will be in your life time. So the best thing you can do is have a portfolio that is immune, that is well diversified.  That is what we call an all-weather portfolio.  That means you don't have a concentration in that asset class that's going to annihilate you and you don't know which one it is.

A Korean Black Swan?

Last week I was in Newport, Rhode Island, at the Naval War College, where I participated in a summer study group focused on possible futures and how they might affect the strategy of the US Defense Department. The discussions were wide-ranging and mind-expanding, at least for me. As readers know, I believe that Japan has begun a long-term process of continually devaluing its currency. For reasons I have written about at length in previous letters, I think the yen could go to 200 to the dollar in the next five years. I don’t see a precipitous move, simply a steady erosion as Japan tries to bring back inflation and export its deflation.

While the yen at its current valuation is not a particular problem for the rest of the world, when it hits 120 we will start to see raised eyebrows and political speeches from the countries most affected. At 140 we could start to see serious reactions.

One of the countries that I think is put into a most difficult situation is South Korea. Their options for responding to a weakening yen are quite limited. If they respond by printing more of their own currency, they are likely to engender a debilitating inflation, which is of course not a good thing. Protectionism will have little real effect vis-à-vis Japan. Remember that the Japanese yen was 357 to the dollar about 40 years ago. The Japanese watched their currency rise by almost 400% in the decades since. The only real response available to them was to simply become more competitive and more productive as their currency got stronger, and to their great credit they did.

Honing their competitive edge may also be the only real option for South Korea. But it is not an easy one, of course, and you will hear lots of complaints from Korean politicians and businessmen. Not an easy environment, to be sure.

Now let’s shift our focus to North Korea. Everyone (including your humble analyst) is worried about the isolationist regime in North Korea having access to nuclear weapons and the ability to deliver them on missiles. But a few conversations I had this past week led me to think there is another scenario we should consider.

A side conversation at the study group began with an observation by a senior officer about the ability of the North Korean military to actually project power. As this information is nothing more than what you can find in the newspapers, I feel comfortable discussing it here. Everyone knows that North Koreans have been malnourished for multiple decades. Studies suggest that North Koreans may be up to three inches shorter than South Koreans and have diminished IQs because of malnourishment as children. The latter is a known effect on human beings anywhere who are subjected to a starvation diet. The North Korean population has suffered from severe diet restriction for decades.

How capable is the North Korean military of actually mounting an offensive when their soldiers are simply not physically able to withstand the pressures of combat? I was also able last week to visit with one of the great geopolitical strategists of our time, Professor Ian Bremmer of Columbia, who is the president and founder of Eurasia Group, with some 100 geopolitical analysts working for him. I shared with him my concerns about the Korean peninsula. He immediately said that he was more worried about the Korean peninsula than any other part of the world, including the Middle East. One of the interesting things that he shared is that an increasing number of cell phones are being smuggled into North Korea from China and that the North Koreans are beginning to get the real story about the world rather than just the propaganda fed to them by their government.

While there is little ability for the North Korean population to actually stage a revolution, as they do not have the weapons and hungry people really have difficulty mounting military operations, there is the possibility of the country becoming increasingly difficult to manage. Combine that with the potential for a disastrous food-production year, and the potential for the collapse of the government is not all that far-fetched.

There were not many people forecasting the collapse of the USSR in 1987. Yet as we look back, the confluence of causes that resulted in its collapse seems rather obvious. Probably, the current dictatorship will maintain its stranglehold on North Korea. That is the tendency with repression and tyranny – witness Cuba and any number of other countries. But one cannot dismiss the possibility of a collapse of the North Korean state.

If that were to happen it would be a humanitarian disaster. In the long run it might be better for the North Korean people, but in the short run it would be catastrophic. It is not unreasonable to expect that South Korea would have to do the bulk of the heavy lifting, especially after the first year or so. And should the world no longer have to focus on the ability of North Korea to create mischief with nuclear weapons, North Korea could soon become page 16 news.

No matter how positively you would want to view Korean unification, the process would be enormously expensive for South Korea. Assimilating a population long challenged by hardship into a new reality, not to mention incorporating it into a modern economic model, is a daunting challenge. I think the task would be more difficult and more expensive on a per-capita basis than the unification of Germany.

And this could happen while the attention of South Korea is focused on dealing with the devaluation of the yen and the need to become progressively more competitive to maintain its export and business model. There is also the possibility of massive refugee movements into China. That is a significantly different issue than worrying about a million-man army crossing the DMZ into South Korea.

I’m not saying this will happen, but it is a possibility we need to keep an eye on.

Maine, Montana, San Antonio, and Bismarck

I’m at Leen’s Lodge in Grand Lake Stream, Maine, at “Camp Kotok,” with about 50 people from all areas of the financial sector: money managers, traders, writers, real economists (as opposed to your humble analyst), financial media, Federal Reserve economists, and other guests. Old friends whose names are familiar to my readers have become regulars here – people like Paul McCulley, Barry Ritholtz, Jim Bianco, David Rosenberg, Mike McKee of Bloomberg, Bill Dunkelberg (chief economist of the National Federation of Independent Businesses), Phillipa Dunne of the Liscio Report, and others too numerous to mention. David Kotok of Cumberland Advisors organizes the event and masterfully crafts the mix of guests and the agenda for the long weekend. Some people have referred to this group as the Shadow Fed, but that is far too serious a moniker for what really happens here. This is one of the more fascin ating discussion groups I ever get to participate in, and I always learn a great deal. I should note that at least ten of our group are women, which makes it somewhat unusual for a financial-industry gathering, but it's a trend I would like to see more of.

This is the seventh year I’ve attended, and each year I’ve come with my youngest son, Trey. He was 12 the first year we came and is now 19. He has grown up with these men and women. Being with my son each year has made this a very special week in my life. Each year's event is an emotional and very personal measuring stick as I watch him grow up. The annual competition to see who among us will catch the most fish is a small part of the experience, but Trey does not let me forget that he has won for six years in a row. After our first rain-soaked half-day of fishing, I am ahead by one, but there are two more full days ahead. Watching him grow up here is very special. There is a part of me that hopes he catches at least one more fish than the old man. But I will never tell him that.

Grand Lake Stream is in the middle of Washington County, Maine, which is about the size of Connecticut yet has only 30,000 people. As it turns out, it is also the poorest county east of the Mississippi. Who knew? Local officials assure me that our gathering of economists is one of the biggest financial events for the area each year. In a few weeks they are going to announce what is a fascinating economic experiment. The state of Maine is going to make the entire county an enterprise zone. They are going to eliminate all taxes in the county – every last corporate, personal, and sales tax. As one former state official told me tonight, the state gets such a small amount of taxes from this county that eliminating the taxes won’t affect the state budget whatsoever. And the poverty here is quite real. I will give you an update, down the road, on whether the Washington County experiment makes a difference. My philosophical bet is that it will. In a few years the results will not be just philosophical but something we can all see.

As long as I keep getting an invitation to return, I intend to spend the first weekend of every August in Maine. It is truly a slice of heaven and one of the gatherings I most look forward to every year.

We go back home on Monday, and then the next week I’m off to Montana with Darrell Cain for a week to read, relax, and gather my thoughts. At the end of the month I go to San Antonio for the World Science Fiction Convention (WorldCon), where I get to play groupie for a few days. Then in the middle of the month I will go to Bismarck, North Dakota (details later), and hopefully make a side trip to South Dakota, which will allow me to finally say that I have been in all 50 states.

It is time to hit the send button, as the group is gathering for Lobster Night. Charles Driza, the owner of Leen’s Lodge, and his staff provide fabulous gourmet meals. And the conversation is even better. Have a great week and find a few friends and family to be with. That time is an investment where the valuation is always rising.

Your soaking up the beauty of Maine analyst,

John Mauldin

Outside the Box is a free weekly economic e-letter by best-selling author and renowned financial expert, John Mauldin. You can learn more and get your free subscription by visiting

Please write to to inform us of any reproductions, including when and where copy will be reproduced. You must keep the letter intact, from introduction to disclaimers. If you would like to quote brief portions only, please reference

John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to:

To subscribe to John Mauldin's E-Letter please click here:

Copyright 2013 John Mauldin. All Rights Reserved
Note: John Mauldin is the President of Millennium Wave Advisors, LLC (MWA), which is an investment advisory firm registered with multiple states. John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS), an FINRA registered broker-dealer. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Millennium Wave Investments cooperates in the consulting on and marketing of private investment offerings with other independent firms such as Altegris Investments; Absolute Return Partners, LLP; Plexus Asset Management; Fynn Capital; and Nicola Wealth Management. Funds recommended by Mauldin may pay a portion of their fees to these independent firms, who will share 1/3 of those fees with MWS and thus with Mauldin. Any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest with any CTA, fund, or program mentioned here or elsewhere. Before seeking any advisor's services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum. Since these firms and Mauldin receive fees from the funds they recommend/market, they only recommend/market products with which they have been able to negotiate fee arrangements.

Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staffs at Millennium Wave Advisors, LLC and InvestorsInsight Publishing, Inc. ("InvestorsInsight") may or may not have investments in any funds cited above.


John Mauldin Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules