- According to John Hussman – the former economics professor turned chairman of the Hussman Investment Trust, known for his consistently bearish views – the return outlook for a well-diversified investor has never been worse.
- Hussman’s thinking can be summed up in two distinct categories: market valuations and internal market data.
- Over the next 12 years, Hussman predicts a return of -1.56% for investors who are 60% in stocks, 30% in bonds and 10% in cash.
- Ultimately, Hussman expects the market to drop 66%.
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“Oh, man. This bubble’s unwinding is going to be painful.”
That’s what John Hussman – the former economics professor turned chairman of the Hussman Investment Trust, known for his consistently bearish views – said in a recent client note with reference to the current stock market.
“I continue to expect the S&P 500 Index to lose two-thirds of its value at the end of the current market cycle,” he said. “This loss would not even violate historical valuation standards, but it would at least bring our estimates of the expected long-term S&P 500 returns closer to their historical average, unlike the negative 10-12 year outlook we are seeing now.”
The reasoning behind Hussman’s call can be broken down into two distinct parts: market valuations and internal market data. According to him, long-term returns are driven by valuations, while short-term returns are driven by investor psychology through sentiment and inclination.
Hussman provides the following example to demonstrate his thinking.
“For example, investors might very well be prepared to pay $ 100 today in exchange for expected cash flow of $ 100 in ten years,” he said. “Of course, this will essentially block an expected return of zero, but nothing prevents rabid speculators from pushing the price down to $ 110 in the short term. In this case, investors will be delighted with the current price, but simultaneously they will see potential negative 10-year returns. “
He continued, “Conversely, risk averse investors may push the price down to $ 46 today, in which case current holders will be in trouble and upset. Yet this is also a price they can hope to get at. an annual return of 8% over the decades. “
It’s no secret that current stock valuations have been moving on the higher side of the historical spectrum for some time now. Investors have pushed prices higher, while earnings remain relatively subdued.
Bank of America recently demonstrated this notion with the following chart. On a variety of different measures, the S&P 500 is well above its historical standards, including averages that rule out the tech bubble.
Historically, when valuations have turned out to be high, investors have shied away from high-priced markets and moved towards the relative safety of bonds for a return. But today, with interest rates at rock bottom, even a well-diversified investor appears to be in a precarious position, according to Hussman’s projections.
Below is Hussman’s estimated 12-year total annual return for a conventional portfolio (60% stocks, 30% bonds, 10% cash – blue line) compared to the actual 12-year returns for that portfolio. wallet (red line) to help demonstrate this idea. Its projections have never been so low. As of November 13, his model predicted a return of -1.56% for the next 12 years.
Yet ratings are only one side of the equation. For Hussman to develop a purely bearish view of the market, he must also see the market’s internals deteriorate. Right now, they seem to be holding on.
“The driving force behind the markets here is not valuation, nor economic growth (other than the usual mean reversion of the output of GDP gap). Instead, it’s this’ psychological knot “investors,” he said.
“It is not necessary to predict when market conditions will change, only to respond to them as they do. At current extremes, the risk of a severe air pocket, panic or crash is high, but we don’t currently have the deterioration – in the internal market that would encourage a purely bearish outlook. “
A break with consensus
With all of the above, it’s important to note that Hussman’s outlook is significantly more pessimistic than that of major Wall Street institutions.
From an equities perspective, while the S&P 500 end-of-year 2020 median price target for all Wall Street equity strategists is slightly below current levels, their forecasts certainly don’t suggest a major stock market crash.
In addition, their S&P 500 earnings per share forecast for 2021 would mark an increase of about 17% year-over-year, according to Bloomberg data. Considering that profit expansion has always been the main driver of stock market gains, this is a positive sign.
For the uninitiated, Hussman has repeatedly made headlines predicting a stock market decline exceeding 60% and predicting a full decade of negative stock returns. And as the stock market continued to rise, he persisted with his calls.
But before you dismiss Hussman as a wobbly permanent bear, consider his background, which he broke down in a recent blog post. Here are the arguments he sets out:
- Predicted in March 2000 that tech stocks would drop 83%, the tech-hungry Nasdaq 100 Index lost 83% “with improbable precision” over a period from 2000 to 2002.
- Predicted in 2000 that the S&P 500 would likely experience negative total returns over the next 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, recent Hussman returns have been less than stellar. Its strategic growth fund has returned just 2.4% in the past year, placing it in the 47th percentile relative to its peers, according to Bloomberg data. And it actually fell 1.4% on a three-year basis, placing it in the 23rd percentile.
Still, the amount of bearish evidence unearthed by Hussman continues to increase. Of course, there may still be returns to be made in this market cycle, but at what point does the growing risk of a crash become too unbearable?
That’s a question investors will have to answer for themselves – and one that Hussman will clearly continue to explore in the meantime.