With the unemployment rate at 11.1 %, the economy running at a fraction of its normal capacity, and a never-before-seen virus still running rampant, it's no wonder why some are skeptical of a stock market that's flat on the year. Couple that notion with market valuations trending on the loftier side of historical norms, and the milieu becomes even more perplexing.
John Hussman— the former economics professor turned president of theHussman Investment Trust who's known for his persistently bearish views — can't seem to make sense of it.
"If someone tells you, 'well, stock valuations are high, but high valuations are justified by low interest rates,' they're actually arguing that passive investors face the worst of all possible worlds," he penned in a recent client note.
"They're saying 'well, future stock returns are likely to be dismal, but dismal returns on stocks are justified because you're going to get dismal returns on bonds too.'"
Hussman's not buying it.
He added: "Last week, our estimate of prospective 12-year returns on a passive investment mix again matched the most negative levels in U.S. history."
Below is a chart Hussman provided of his proprietary estimated 12-year annual total return for a conventional portfolio (60% stocks, 30% bonds, 10% cash — blue line) compared against the actual subsequent 12-year returns for that portfolio (red line).
Leaning on today's valuations, Hussman says that the 10-year total return for the S&P 500 will "likely" be about negative 1.4% annually.
Drilling down even further, Hussman compares one of his favorite valuation metrics — called margin-adjusted price-to-earnings ratio — against the S&P 500 index, with dividends discounted at a 10% rate. To him, this measure is more closely correlated with subsequent market returns. Today, his model is showing valuations consistent with the Great Depression and tech bubble.
"Perhaps it's needless to observe that current valuations on all of these measures match those of 1929 and 2000. I'll observe it anyway," he said. "Current valuations are essentially triple those that would be consistent with historically run-of-the-mill stock market returns of about 10% annually."
Still, Hussman's not ready to throw in the towel on the market until market internals, a proprietary metric he's fashioned to calibrate the level of speculation in stocks, takes a turn for the worse. Unfortunately, Hussman says that a recent improvement in the metric "proved temporary."
To help demonstrate the level of optimism present, Hussman leans on the CBOE put/call ratio, a metric that compares the amount of bullish option bets to bearish option bets.
"There are few times in history that investors were quite so optimistic in the option market," he said. "To be clear: our most reliable market valuation measures presently match the 1929 and 2000 extremes, and our gauge of internal uniformity is also unfavorable."
To Hussman, that confluence of negative market factors converging on a shaky economy is cause for concern — and if the tides start to turn, he thinks investors will be in a world of hurt.
"If there is mean-reversion in valuations, as there has been during every market cycle in history, including those since 2000, the outcome will be catastrophic for investors over the completion of this cycle, because it implies a nearly two-thirds loss in the S&P 500 simply to reach pedestrian historical norms," he said.
"Even a 50% market retreat would bring valuations only to levels matching the 2002 low, which was the highest valuation level ever observed at the completion of a market cycle."
He added, "Over the completion of the current market cycle, I expect that the entire S&P 500 total return since 2000 will be wiped out. Specifically, I continue to expect the S&P 500 to lose about two-thirds of its value."
Hussman's track record
For the uninitiated, Hussman has repeatedly made headlines by predictinga stock-market decline exceeding 60%and forecasting afull decade of negative equity returns. And as the stock market has continued to grind mostly higher, he's persisted with his calls, undeterred.
But before you dismiss Hussman as a wonky perma-bear, consider his track record, which he broke down in his latest blog post. Here are the arguments he lays out:
- Predicted in March 2000 that tech stocks would plunge 83%, then the tech-heavy Nasdaq 100 index lost an "improbably precise" 83% during a period from 2000 to 2002
- Predicted in 2000 that the S&P 500 would likely see negative total returns over the following decade, which it did
- Predicted in April 2007 that the S&P 500 could lose 40%, then it lost 55% in the subsequent collapse from 2007 to 2009
In the end, the more evidence Hussman unearths around the stock market's unsustainable conditions, the more worried investors should get. Sure, there may still be returns to be realized in this market cycle, but at what point does the mounting risk of a crash become too unbearable?
That's a question investors will have to answer themselves — and one that Hussman will clearly keep exploring in the interim.
