John Hussman: Post Crash Bubbles

Excerpt from the Hussman Funds' Weekly Market Comment (5/11/09):

It would be very convenient if it was possible to buy the fear lows, participate in the bear market rallies, sell at the peaks, and repeat. Unfortunately, “fear” lows are only evident in hindsight, because as we saw in 2008, a deeply oversold market can become spectacularly more oversold before recovering, and the “fast, furious” spikes off of those lows are often followed by steep failures. Fear lows are only easy to identify in hindsight.

Even if we have observed the ultimate lows of this downturn (which I would not take as given), it does not follow that the decline we've observed over the past 18 months will be progressively recovered without a great deal of intervening difficulty. The S&P 500 has retraced just over 25% of its bear market loss. The 904 level on the S&P 500 was a 25% retracement, and 977 would be a 1/3 retracement, which is not unreasonable. Aside from such retracements, the idea of a “V-shaped” recovery in the market is strongly odds with “post-crash” market behavior, which generally features a long and drawn-out flat period for years afterward. Given the enormous overhang of Alt-A and option-ARM resets scheduled to begin later this year, extending into 2012, such a profile would not be surprising in the present case.

To put the current downturn into similar context, the chart below overlays several historical crashes, with the time scale measured in months. The downturns include the Great Depression (purple), the Japanese Nikkei index which peaked in 1989 (blue), the gold market which peaked in 1980 (green), and the S&P 500 which peaked in 2007 (red). Thanks to Bill Hester for preparing this overlay.

Note that during all of these downturns, the markets did experience very powerful intervening advances as well (indeed, the rally off of the initial 1929 market crash approached 50% before failing). In each case, however, the fundamentals of the preceding bubble had been broken and it took years for the markets and economy to adjust. In the case of gold, the shift in fundamentals was the end of double-digit inflation. In the other instances, including the present one, the shift was from a steeply leveraged economy to a deleveraging one.

To a great extent, the optimism of investors is based primarily on economic “flow” data (spending, job losses, confidence measures) that remain poor, but have been “less bad” than expected. What concerns me far more, however, is that there is a second and almost equivalent mountain of mortgage resets and probable defaults that will begin later this year and extend into 2012. While our unelected bureaucrats have spent over a trillion dollars to make reckless lenders whole, they have done nothing to materially ease foreclosures or avert the oncoming second wave.

Comments

[Larry House:]

Thanks, John. Good insight. To say nothing of the commercial real estate and credit card problems still mounting.

May 11 04:22 PM

[user396040:]

Interesting analysis. What is unique about our situation here is the extreme expansive policy of the Federal Reserve. I don't think it guarantees a recovery because we also have an unprecidented credit mess on our hands; but it does make the current situation different from some of these earlier examples. I find it hard to imagine a scenario in which buying Treasuries at current prices will produce a better return five years from now in comparison with buying a portfolio of solid dividend paying stocks(e.g., JNJ, PG, MSFT, T, XOM, MCD, VZ, KO).

May 11 06:39 PM

[Sovestor:]

Good insight with good chart. One thing to add: the positive feedback cycle may continue if many large financial companies in needs to capital were able to quickly and successfully raise capital from private investors.

May 11 07:20 PM

[Francisco M...:]

Cetin, this is an unprecedented recession. Forget 1991, 1982, 1974 or 2003. What is happening here is not just deleveraging on the corporate side of the equation; you now have individuals doing the very same thing. That means a steep correction in GDP numbers and the rest I leave in the open for speculation.

May 11 11:00 PM

[Alphameister:]

I likewise expect the future of the U.S. stock market to be found somewhere in those charts of past crashes and aftermaths. I am hoping the long-term prospects are brighter for emerging markets, especially China, where the current cyclical recovery seems more likely to be part of a secular bull market.

May 12 10:50 AM

[Subhankar:]

There is no point in trying logic with Cetin. His relentless efforts to promote his blog with a bullish stance reminds me of a comment about bulls: other than beef, what do they produce in large quantities?


On May 11 11:00 PM Francisco Martin wrote:

> Cetin, this is an unprecedented recession. Forget 1991, 1982, 1974
> or 2003. What is happening here is not just deleveraging on the corporate
> side of the equation; you now have individuals doing the very same
> thing. That means a steep correction in GDP numbers and the rest
> I leave in the open for speculation.

May 12 11:34 AM

[Tony Daltorio:]

Cetin, have you asked the powers that be to change the date on the calendar?

This isn't 2009. According to Cetin, all history is contained within the last 20-30 years.


On May 11 10:05 PM Cetin Hakimoglu wrote:

> That t wasn't the case in 1991, 1982, 1974, or 2003 which exhibited
> V shaped recoveries. Just pull up some graphs and you will see.
>
>
> ----------------------...
> Aside from such retracements, the idea of a “V-shaped” recovery in
> the market is strongly odds with “post-crash” market behavior, which
> generally features a long and drawn-out flat period for years afterward.

May 12 01:20 PM

[Fred Voetsch:]

Good article full of common sense. It's the same that I hear from every wise old owl who has been around the block a few times and understands that we are in a generational correction that has nothing whatsoever to do with the 80's or 90's or anything you have EXPERIENCED. Only those who study and understand, or have lived history can get it.

May 12 05:14 PM

[Fred Voetsch:]

On May 11 11:00 PM Francisco Martin wrote:

> Cetin, this is an unprecedented recession. Forget 1991, 1982, 1974
> or 2003. What is happening here is not just deleveraging on the corporate
> side of the equation; you now have individuals doing the very same
> thing. That means a steep correction in GDP numbers and the rest
> I leave in the open for speculation.


Someday Cetin will be a wise old owl who actually gets it and I imagine, given the way he promotes himself, that he will be every bit as succesful as...well...maybe Jim Cramer? And perhaps as well respected.

Something to think about, Cetin.

May 12 05:18 PM

[Hot Richard:]

I regrip and squeeze again before I throw out the lemon. Bear markets do the same. Investors, you're the lemon.

Guys, read Cetin ironically and he's a little better.

May 12 05:18 PM

[Hot Richard:]

"While our unelected bureaucrats have spent over a trillion dollars...they have done nothing to materially ease foreclosures or avert the oncoming second wave."

Wanted to point out how good this statement is...and important. The US Government hasn't done anything to materially make the economy better--but they have done a whole lot to make it worse. That's my stance.

May 12 05:22 PM