John Hussman’s latest weekly article is called “Measuring the Bubble“.
The following snip is lengthy, but not in comparison to Hussman’s original text which I encourage everyone to read in full. Hussman displayed 9 charts and tables, I only snipped one of them.
I dispense with my usual blockquotes for ease in reading. The end of the snip should be easy to find.
Begin Hussman: Measuring the Bubble
Critics of value-conscious investing have argued that even the most reliable valuation measures have been extreme for years now, and can therefore be disregarded, since the market has continued to advance. Hold on Scooter. It’s important to distinguish between the level of valuations, which has indeed become breathtakingly extreme in recent years, and the mappingbetween valuations and longer-term market returns (which we observe as a correspondence, where rich valuations are followed by poor returns and depressed valuations are followed by elevated returns). That mapping has remained intact, even in recent market cycles.
The essential thing to understand about valuations is that while they are highly reliable measures of prospective long-term market returns (particularly over 10-12 year horizons), and of potential downside risk over the completion of any market cycle, valuations are also nearly useless over shorter segments of the market cycle. The mapping between valuations and subsequent returns is typically most reliable over a 10-12 year horizon. That’s the point where the “autocorrelation” of valuations (the correlation between valuations at one point in time and valuations at another point in time) typically hits zero.
Now, it’s true that when we examine pre-crash extremes, like 2000 and 2007, we’ll typically find that actual returns over the preceding 12-year period were higher than the returns that one would have expected on the basis of valuations 12 years earlier. No surprise there. The only way to get to breathtaking valuations is to experience a period of surprisingly strong returns. Those breathtaking valuations are then followed by dismal consequences. Likewise, when we examine secular lows like 1974 and 1982, we’ll find that actual returns over the preceding 12-year period fell short of the returns one would have expected on the basis of valuations 12 years earlier.
The chart below offers a reminder of what this looks like, in data since the 1920’s. Look at the “errors” in 1988, 1995, and 2006. Count forward 12 years, and you’ll find the major valuation peaks of 2000, 2007 and today that were responsible for the overshoot of actual returns. The 2000 and 2007 instances were both followed by losses of 50% or more in the S&P 500. Look at the “errors” in 1937, 1962, 1966, and 1970. Count forward 12 years, and you’ll find the market lows of 1949, 1974, 1978 and 1982 that were responsible for the undershoot of actual returns. Those market lows turned out to be the best buying opportunities of the post-war era. When market cycles move to extreme overvaluation or undervaluation, they become an exercise in borrowing or lending returns to the future, and then surrendering or receiving them back over the remaining half of the cycle.
Measure what is measurable
Put simply, in my view, stock prices are rising not because Wall Street has thoughtfully quantified the effect of taxes, interest rates, corporate profits, or anything else. Instead, Wall Street is mesmerized by the self-reinforcing outcomes of its own speculation, relying on verbal arguments, optimistic projections lacking grounds in observable data, and enthusiastic assertions about cause-effect relationships that are accepted without the need for any evidence at all (much less decades of it).
Back to Galileo. Measure what is measurable, and make measurable what is not so. When we do this, come to understand the current speculative extreme as the tension between two observations that are not actually contradictory – just uncomfortable. One is that stock prices are indeed three times the level at which they are likely to end the current market cycle. The other is that there is no pressure for valuations to normalize over shorter segments of the cycle, as long as risk-seeking speculative psychology remains intact.
I expect the S&P 500 to lose approximately two-thirds of its value over the completion of this cycle. My impression is that future generations will look back on this moment and say “… and this is where they completely lost their minds.”
John P. Hussman
PermaBear?
Is Hussman a PermaBear? No, not really, but it’s easy to believe so, because for years on end he has been saying the same thing.
History suggests its unwise to invest at these stock market levels. GMO’s expected returns are similar.
Some of my new readers were shocked when I posted that chart. However, GMO has been posting similar charts for at least a couple of years.
GMO’s forecast goes out 7 years, Hussman’s 10-12 years. There’s plenty of room for more downside in the GMO position.
Ride the Wave
Bulls and even many bears will ride the wave for all its worth and then ride it all the way back down again.
In fact, it’s impossible to do otherwise. Someone has to hold every stock and every bond 100% of the time.
Pension Fund Disaster
The sad part of this story is that despite the biggest bull market in history, pension funds are extremely underfunded.
Whether the decline is 33%, 50%, or 66%, pension funds will get crushed.
Heck, given 7% per-year assumptions, even flat returns for seven years will destroy many if not most of them.
Mike “Mish” Shedlock
link to obatperangsangmanjur.net
Reading Hussman for many years, he would be my 1 read if made to choose and highly respect his opinion and research.
drhotdog. I don’t mind people chiming in with well reasoned arguments for being perpetually long the stock market i.e. the only credible argument is that fractional reserve banking system has unleashed an unholy amount of monetary inflation over the past few decades. But when they start babbling about value this and growth that, the naivety meter starts to head to “11” with great haste. Hussman’s analysis is fundamentally correct and I believe he will be proven correct in time (if not nominally, certainly in ‘real’ terms) but his mistake has been to ignore the Central Bank manoeuvres which have been instrumental to boosting risk assets and prevented the stock market crash of ’08 from completing its cycle . There are a conga line of idiots on blogs who opine but don’t understand (El Tedo etc). The GFC was a debt crisis (sub-prime was the trigger not the problem) and global debt then was $140trn. Today that total is $235trn+. The point that people fail to grasp is that, debt is senior to equity in the average capital structure i.e. when a company fails, equity holders get wiped out (because they are at the bottom of the pile) and debt-holders become the new owners of the company. With corporate debt now nearly 70% higher today than during the GFC what does that do to equity values in the next crisis? You could easily argue that the aggregate cram-down is going to be even more severe this time because the weight of debt makes the value of equity far less in a recession / depression. In other words, Hussman’s estimate that equity values falling two thirds over the completion of the next cycle may be too optimistic. This is a complex situation that demands a degree of humility from those utterly unequipped to opine on it. Perhaps time spent learning instead of spewing uneducated garbage on blogs would be more profitable in the long run.
should read ….would now have a…(second last line
Hussman’s graphs are in fact understated because GVA has been artificially inflated by revisions to the 2013 System of National Accounts which capitalised R&D and in-house software. These outstanding and highly significant graphs need to be adjusted for the rise in inequality which has seen the top 5% hoover up all the extra income, and then invest it primarily in shares. This has two effects. Firstly it makes current data incommensurate with previous data. It is to be expected that shares would be more highly valued and that this would be the new normal. Secondly, because personal consumption is so highly dependent on the movement in share prices, a proportionate fall in share prices would not have a disproportionate effect on the economy compared to previous crashes.
Down nearly 5% over 7 years, that is a real bear market. Even the presidency of GW Bush which included two selloffs, the stock market returned 3% over the eight years, so down this much, that is scary.
Hussman is very smart about one set of facts, but he doesn’t know what to do with the other causes of market prices. Same is true of Prechter. One of the hard lessons in life is that being half-right, or brilliant within a limited perspective, doesn’t actually help you. Hussman’s “Strategic Growth Fund” has averaged -6% over 10 years, which speaks for itself.
Hussman has never predicted any downturns in 2000 or 2008, since the first day he saw a stock chart he has predicted a downturn.
The point is it will look good ONLY if the central banksters intervene. Also it looks like while one central bankster could do it in 2000, it needed all the central banksters to be at work since 2008, working in a coordination. Does this indicate that the Atlas (central banksters) have to carry a bigger and bigger load to keep propping up the system? Can they do it for ever?
Why a period of 18 years, why not 9 years (Mar 2009)? What would the return have looked like then?
“Here’s what money managers and bloggers never tell you. If you bought the Nasdaq in Mar 2000, the absolute peak of Dotcom bubble, and put $100 per month every into a low cost fund your return per yr over the last 18 years is 10.7%/yr or 201%.” And what will it be if the Nasdaq crashes 76% a second time?
Aha, a new feature, the ability to reply to a specific post, let’s try it out. I personally haven’t capitulated. I still trade long at times, short at others. When the market is going parabolic, obviously that strategy doesn’t work as well as buy and hold, but over the long term it has served me well.
Hussman is a good writer. He can explain his position and his arguments very well, and his charts tend to back up his analysis. He also is professional enough to admit his mistakes of over-bearishness and the reasons why over the past several years and doesn’t usually fail to mention those errors. Yes, he has been wrong; but who hasn’t at times. The problem is you don’t want to let it cost you a lot of money following wrong advice by buying into a narrative in the face of factual evidence; i.e., the market has been going up for the past 8 years and it was evident to anyone’s 5 year old child when they looked at a chart. So, what’s the lesson here? If the market is going up, stay with it until further evidence tells you different. If it is going down, have an exit strategy.
It sounds like we’ve all capitulated; no wonder the market was down almost 200 points today.
I’m a value believer but years ago I discovered a real truth: value stocks can easily become even more valuable as you wait for the rest of the market to discover them. Rather than waste money & time waiting, I attached a technical model to my investing & no longer tie up good money. I enjoy Hussman’s letters but like most value guys, he never seems to know when his predictions will come true.
“Measuring the Bubble” 230+ trillion debt globally and counting.
That’s a little disrespectful to the host, but I think your point is correct. Trying to time these markets is a fool’s errand. I’ve fallen to that myself at times. When I’ve done well, it looking for undervalued individual securities, not undervalued markets. I do think there’s is some value to looking at these market measures, thought, to hedge your bets. I wouldn’t put a lump sum to work in the markets at these levels. Better to dollar cost average and diversify.
“Here’s what money managers and bloggers never tell you. If you bought the Nasdaq in Mar 2000, the absolute peak of Dotcom bubble, and put $100 per month every into a low cost fund your return per yr over the last 18 years is 10.7%/yr or 201%.” And what will it be if the Nasdaq crashes 76% a second time?
I tend to follow the readings of Hyman Minsky. The most dangerous markets are those that go up 10-15% a year over a 8-9 year period. Are we due a Minsky Moment this year? I think so.
@Escierto:
Absent limitations on resources, everyone is infinitely rich forever. And there is no economics.
Printing the image of George Washington’s head on paper pieces, doesn’t magically create more resources. Instead, all it does, is transfer existing resources: To those with early, cheap and easy access to the fresh print. And consequently, from everyone else. Most importantly, in economic terms, from those who do productive work, creating and extracting the resources in the first place.
Robbing the latter via printed-into-being “asset appreciation” can work for a while. But eventually, just as happened to the Soviets, and now Chavezians; sooner or later, you do run out of other people’s money, and productive output, to steal. As neither is “unlimited”.
The vast majority of the money invested by pensions are debt instruments. So their poor returns compared to equities is expected.We’re clearly in a bubble and bubbles do not slowly deflate. At some point Hussman will be partially vindicated. My guess is we have less then a year before all hell breaks loose.
The market can never go down as long as the central banks are buying and printing money. Has there ever been a market where the principal buyers had unlimited resources to buy without end?
He’s intelligent, Hussman, and writes well, but I don’t respect how he hasn’t owned up to his poor track record. Writing his mistakes off as some kind of virtue, ‘As as fiduciary, I erred on the side of caution, stress-testing for a depression’ (that’s a paraphrase, but accurate. He brings the point up in almost every column.Like a politician, when asked what his flaw is, who says ‘My flaw is that I’ve underestimated the depravity of my opponent.’ He missed most of the recover post-March 2009. What’s the point of being a strict value investor if you don’t pounce when there’s blood on the street.
He’s many times mentioned his admiration of, and friendship for, Jimmy Carter, including calling him one of the three of the three peacemakers he admires most, along with Dr. Martin Luther King, Jr. and Thich Nhat Hanh. I don’t think too many Jews would agree with him.
Is Jimmy Carter a Hero to Hussman? Even if so, that’s an ad hominem attack
Hussman’s investment track record is about what you’d expect from an investment manager who sites Jimmy Carter as his hero. Is the stock market expensive today from a value point of view? Without question. Is it plausible for the DOW to be trading below 9,000 without some triggering, black swan even? No. Hussman now believes the market is more expensive than at the peak of the dotcom bubble, which is ridiculous.