By Henry Blodget
Fund manager John Hussman, who is one of the most disciplined, knowledgeable, and fact-based investors around, has struggled mightily in recent years. Hussman’s valuation models and technical indicators have all been flashing yellow and red lights for years. As a result, Hussman has positioned his funds cautiously…and therefore missed out on some of the bonanza that has powered stocks to extraordinary new highs.
As any investment professional will tell you, on Wall Street you have about 90 days to be “right.” If you make a market call that goes against you for longer than 90 days, you’re not considered “early” or “prudent” or “careful.” You’re considered “wrong.” And, soon, if you stick to your guns, people begin to regard you as a religious fanatic–too wedded to your incompetency and pride to admit your mistake and join the happy, comfortable, consensus herd. And then people write you off as a “perma-____” and stop listening to you.
Hussman’s caution and underperformance over the last few years have damaged his reputation and caused a lot of people to stop listening to him. And that’s too bad, because sometimes big market trends take a long time to play out. And, sometimes, it’s only after a bold, stubborn analyst has been dismissed as an out-of-touch charlatan that a market imbalance is finally corrected.
I will go out on a limb here and say that I think there’s a good chance that John Hussman will ultimately be proven right. Even if the market doesn’t actually crash, I think it’s highly likely that stock returns will be lousy for the next ten years. Yes, as John Hussman will be the first to admit, there’s also a chance that it’s different this time and that his caution is unwarranted. But it’s worth stressing that that is the only way John Hussman will not ultimately be proven right—if it’s “different this time.” Because every historical indicator Hussman is looking at is suggesting that the stock market is wildly overvalued and headed for a period of lousy returns. How lousy? John Hussman thinks there’s a good chance the stock market will soon crash 40-50 percent. A crash of that magnitude would take the DOW from 15,000 to 7,500-8,500.
And even if the market doesn’t crash, Hussman thinks stocks are priced to produce returns of only a couple of percentage points per year over the next decade—far below the 7 percent inflation-adjusted long-term return that everyone is used to and the double-digit returns of the last few years. If you want to feel comfortable and happy, go ahead and ridicule John Hussman with everyone else. If you want to prepare yourself for what seems like a likely possible stock-market future, however, read on:
Frankly, I wonder whether any amount of arm-waving will incline investors to actually examine their risk exposures here, much less consider the prospect of a 40%+ decline in the S&P 500 Index that would be required simply to bring stocks to historically run-of-the-mill valuations. But at a time when our estimates of prospective risk are surging, I would be remiss not to observe that fact.
At present, we have what might best be characterized as a broken speculative peak, in that market internals (particularly interest-sensitive groups), breadth and leadership have broken down uniformly following an extreme overvalued, overbought, overbullish syndrome. If you recall, the market also recovered to new highs in October 2007, weeks after the initial, decisive break in market internals at that time. Presently, we’re looking at the same set of circumstances. On some event related to tapering or the Fed Chair nomination, we may even see another push higher. It isn’t simply short-term risk, but deep cyclical risk that is of concern.
Now, even if take Hussman’s warnings seriously, it’s still tough to figure out what you should do about it. Bonds and cash also look like lousy investments these days, and real-estate isn’t exactly a screaming buy. So even if you conclude that there’s a good chance that stocks might drop 40-50 percent, you might decide just to ride the plunge out. But at least you will have been prepared for it.