- November 21, 2020
- Posted by: Stratford Team
- Category: Markets
TIMOTHY CLARY/AFP/Getty Images
- According to John Hussman — the former economics professor turned president of the Hussman Investment Trust who’s known for his persistently bearish views — the return prospects for a well-diversified investor have never been worse.
- Hussman’s thinking can be boiled down to two distinct buckets: market valuations and market internals.
- Over the next 12 years, Hussman is projecting a -1.56% return for investors who are 60% in stocks, 30% bonds, and 10% cash.
- When all is said and done, Hussman expects the market to drop 66%.
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“Oh, man. The unwinding of this bubble is going to be painful.”
That’s what John Hussman — the former economics professor turned president of the Hussman Investment Trust who’s known for his persistently bearish views — said in a recent client note in reference to today’s stock market.
“I continue to expect the S&P 500 Index to lose two-thirds of its value over the completion of the current market cycle,” he said. “That loss would not even breach historical valuation norms, but it would at least bring our estimates of long-term expected S&P 500 returns closer to their historical average, in contrast to the negative 10-12 year prospects we observe at present.”
The reasoning behind Hussman’s call can be distilled into two distinct portions: market valuations and market internals. The way he sees it, long-term returns are steered by valuations, while short-term returns are carried by investor psychology through sentiment and penchant.
Hussman provides the following example to demonstrate his thinking.
“For example, investors may very well be willing to pay $100 today in return for an expected $100 cash flow a decade from now,” he said. “Sure, doing so will essentially lock in an expected return of zero, but nothing prevents rabid speculators from driving the price to $110 in the short run. In that case, investors will be thrilled with the current price, but they will simultaneously be locking in negative prospective 10-year returns.”
He continued: “Conversely, risk-averse investors may drive the price down to $46 today, in which case current holders will be distressed and upset. Yet that’s also a price from which they can expect to obtain an 8% annual return over the subsequent decade.”
It’s no secret that today’s market valuations have been churning on the loftier side of the historical spectrum for quite some time now. Investors have bid up prices, while earnings remain relatively muted.
Bank of America recently demonstrated this notion with the following graph. On a variety of different metrics, the S&P 500 is churning well above its historical norms, including averages that exclude the tech bubble.
S&P, Compustat, Bloomberg, FactSet/First Call, BofA US Equity & Quant Strategy
Historically, when valuations proved lofty, investors would flee richly priced markets and head for the relative safety of bonds to garner a return. But today, with interest rates on the floor, even a well-diversified investor seems to be in a precarious position, according to Hussman’s projections.
Below is Hussman’s 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) to help demonstrate this idea. His projections have never been lower. As of November 13, his model forecasted a -1.56% return for the next 12 years.
Still, valuations are only one side of the equation. In order for Hussman to develop an outright bearish view of the marketplace, he needs to see market internals deteriorate as well. Right now, they seem to be holding firm.
“The driving force behind the markets here isn’t valuation, and it isn’t economic growth (aside from the usual mean-reversion of the GDP output gap). Instead, it’s that “psychological node” of investors,” he said.
“It’s not necessary to predict when market conditions will change, only to respond to them as they do. At present extremes, the risk of a severe air-pocket, panic, or crash is elevated, yet we don’t currently have the deterioration in market internals that would encourage an outright bearish outlook.”
A departure from the consensus
With everything that’s been laid out above, it’s important to note that Hussman’s outlooks are markedly more pessimistic than those held by major Wall Street institutions.
From the perspective of stocks, while the median 2020 year-end S&P 500 price target for all Wall Street equity strategists is slightly below current levels, their forecasts certainly don’t suggest a major market crash.
Further, their consensus S&P 500 earnings-per-share forecast for 2021 would mark a roughly 17% year-over-year increase, according to Bloomberg data. Considering profit expansion has historically been the biggest driver of stock gains, that’s a positive sign.
Hussman’s track record
For the uninitiated, Hussman has repeatedly made headlines by predicting a stock-market decline exceeding 60% and forecasting a full decade of negative equity returns. And as the stock market has continued to grind mostly higher, he’s persisted with his calls.
But before you dismiss Hussman as a wonky perma-bear, consider his track record, which he broke down in a recent 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.
However, Hussman’s recent returns have been less-than-stellar. His Strategic Growth Fund has returned just 2.4% over the last year, putting it in the 47th percentile relative to peers, according to Bloomberg data. And it’s actually declined 1.4% on a three-year basis, putting it in the 23rd percentile.
Still, the amount of bearish evidence being unearthed by Hussman continues to mount. 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.