Jesse Felder: Extreme Valuations

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John Hussman: Pushing Extremes

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In calling the current market the third “Real McCoy” bubble of recent decades, Jeremy Grantham described, in his own words, what I call the Iron Law of Valuation: a security is nothing more than a claim on some set of future cash flows that investors expect to be delivered into their hands over time. The higher the price an investor pays today for some amount of cash in the future, the lower the long-term return the investor can expect on that investment.

However, there’s a difference between those long-term return prospects, which are driven by valuations and discounted cash flows, and short-term return prospects, which are driven by the psychology of investors – particularly their inclination toward speculation or risk-aversion. I talk about this in terms of market internals. Grantham describes it as a “psychological node.” We may navigate that aspect of the financial markets in different ways, but both of us recognize that the long-term prospects implied by valuations don’t condense into short-term implications for market direction.