John Hussman: Multiples Come Back to Earth

Excerpt from the Hussman Funds' Weekly Market Comment (12/15/08):

I continue to view the market as undervalued, but clearly 20% less so than a few weeks ago. Of course, a 20% difference is material. While our investment stance remains modestly constructive on the basis of valuation, we have somewhat less exposure to market fluctuations than we had a couple of weeks ago when prices were extraordinarily compressed. What bothers me about the recent rebound is the tepid volume and general lack of leadership. We certainly don't observe market action from any industry group that reveals investor expectations for an economic recovery. The advance we've seen is better characterized as a short squeeze, and a period where investors have “stepped back” from extreme panic, rather than something that reflects investors “looking across the valley to the eventual recovery.”

...

My guess, and it's only a guess, is that the general tenor of the market may remain tepidly positive for a few more weeks, but that we will ultimately observe another frightening leg down in the first part of next year – possibly to re-test the November lows, possibly to new lows, depending on the evolution of economic conditions. The problem isn't that stocks are expensive – they're not. The problem is that the U.S. economy will probably not see the beginnings of a recovery until the second half of 2009, and while we've seen a good deal of fear, the stock market tends to go through a great deal of sideways action after panics like we've observed. It's likely that stocks will trade in a very wide 25-35% range for months. We have to be particularly observant as stocks approach the higher end of that range.

...

A number of investors have asked about the potential for bankruptcies to disrupt the long-term assumptions that we make about earnings and cash flows, especially for the S&P 500. The most important observation is again that the past 10-15 years were an anomaly from the perspective of profit margins and return on equity. We will almost certainly see some departure from those extremes, but the “normalized” figures we use have been well below those figures for quite some time. What's really happening now is that the actual figures are reverting to their norms.

...

Presently, the price/peak-earnings multiple on the S&P 500 is just over 10, but that is based on peak earnings of about $86 for the Index. If we estimate a conservative level of normalized earnings for the S&P 500 in the range of $65-70, the current level for the S&P 500 would put it at a price-to-normalized earnings multiple of 12.5 to 13.5, which is in the undervalued range, but certainly not near a historical low. A multiple of about 9 times normalized earnings would easily form the base for a powerful multi-year advance in the market, and strong long-term returns. Unfortunately, that multiple would put the S&P 500 at about the 600 level. As I've noted before, I don't expect that we'll observe the 600 level in the current downturn, but we also can't rule it out, and we are very mindful of the potential to “overshoot” to the downside, which has historically occurred even in undervalued markets.

Comments

[Moses:]

"As I've noted before, I don't expect that we'll observe the 600 level in the current downturn..."

He is right, we wont see 600 on the S&P, we will skip right over 600 level straight to the 500 level.

2008 Dec 15 11:56 AM

[CFA Monk:]

Dr. Hussman: I'm 35. My portfolio is as follows:
401K: $30k HSGFX
IRA: $10k VTRIX, $10K VGENX
Cash: $25k

I live in a Zen temple on a stipend of <$5000/year. Although I have lucrative opportunities even in the current financial climate, I'm not likely to earn or save much in the next five years.

I invested in HSGFX in 2001 (despite the inexorable arithmetic of expense ratios) because I'd read your articles on fitness and thought you were an obsessive nerd with lots of discipline.

My major concern about my portfolio over the next ten years is the value of the dollar. We still have a huge current account deficit and there appears to be a growing bubble in Treasuries. In your weekly comment you haven't mentioned this in some time. What is your long-term view of dollar-denominated assets? If, in fact, most of your liquid assets are in Hussman Funds, have you hedged the dollar?

Also, will you PLEASE PLEASE PLEASE offer your (and Bill Hester's) writings as an RSS feed?

Thanks.

2008 Dec 16 05:03 PM

[MarketVViz:]

I can't figure out how to comment on another Hussman article about mortgage resets:
seekingalpha.com/artic...

(I think commenting is not enabled on that article?) and I don't have Dr. Hussman's email. I was wondering if anyone could shed some light on the issue of mortgage resets. Hussman's article has a graph that shows the bulk of ARM resets has already occured (which is some minor positive for the economy going forward I suppose). But recently Credit Suisse published what I think was intended to be the same sort of graph, only theirs looks totally different! See it here:
www.calculatedriskblog...

Can anyone explain this? The Hussman graph doesn't break out Option ARMS separately - which leaves me wondering - did Hussman miss them completely? Or is the new Credit Suisse graph double counting? Why do those option arm resets only seem to "pop into existince" in the future (i.e. 2009?). I'll have to search for the raw data - this is such a huge difference that it might change my outlook on the economy (not that I'm optimistic as it is).

2008 Dec 17 09:27 AM

[MarketVViz:]

Actually just to clarify, the Credit Suisse graph came out first, Hussman's is the newer release.

2008 Dec 17 09:30 AM