Summary List Placement
“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.
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 …read more
Source:: Business Insider