By Richard Morey
May 2023
The Views of Dr. John Hussman
In the following three paragraphs, (from Fabricated Fairy Tales and Section 2A), Dr. John Hussman explains where the stock market is presently positioned. In terms of valuation, our market remains in rarefied air only previously reached in 1929 & 1930, and 2000. According to Dr. Hussman, apparently reversion to the mean hasn’t yet been removed from the equations that determine prices.
Dr. Hussman’s first paragraph describes how investors are presently hoping the Fed will start lowering interest rates. In reality, by far the largest stock market losses occur when the Fed is aggressively lowering rates:
“A decade of quantitative easing has led investors to imagine that Fed easing reliably supports the stock market, and that it is Fed easing that ends market collapses. The fact is that the Fed eased persistently and aggressively through both the 2000-2002 and 2007-2009 collapses. Historically, the worst market outcomes have typically occurred when the Fed is easing in an environment that combines economic weakness with risk-aversion among investors. If one believes that a Fed “pivot” is something that investors should hope for, one is not paying attention.”
In this next paragraph Dr. Hussman explains how stocks will need to fall 60% – from here – to reach average prices based on their relationship to revenue growth and profit margin growth + dividends. I would mention that the other peak was the January 2000 tech stock bubble peak which was right with both 1929 and our recent, December 2021 bubble peak. We’re now slightly below that – on the first ledge down a big mountain as it were.
“At present, our most reliable equity market valuation measures remain more extreme than at any point in history prior to December 2021, with the exception of a few months directly surrounding the 1929 peak, and two weeks in April 1930. Meanwhile, our primary gauge of market internals remains unfavorable, based on uniformity and divergence of market action across thousands of individual stocks, industries, sectors, and security-types, including debt securities of varying creditworthiness. Those conditions may change, but for now we continue to estimate the likelihood of negative 10-12 year S&P 500 total returns, with the prospect of interim losses on the order of -60%. I recognize that these projections seem preposterous, but that is the situation that more than a decade of Fed-induced, yield-seeking speculation has now created for investors. For an extensive, data-rich discussion, see my February comment, Headed for the Tail.”
Here’s Dr. Hussman’s conclusion, in which he describes what he believes is now ready to occur. This doesn’t mean he knows what will occur, but all the necessary conditions have been met for the words we’ve put in bold below:
“While a shift back toward speculative investor psychology would not relieve the extremely poor long-term outlook for the equity market, it could certainly defer those consequences. My impression is that the window for such improvement is narrowing, given that measures of deteriorating employment conditions are gradually joining leading measures that have been pointing toward recession for months now. At current valuations, an improvement in our measures of market internals wouldn’t provide the basis for a bullish investment outlook, but it would suspend the immediacy of our bearish outlook. For now, conditions remain in what I often describe as a “trap door” situation. A market collapse, at its core, is really nothing but risk-aversion meeting a market that is not priced for risk.”