John Hussman: The Outlook Is Not Up, But Very Widely Sideways

Excerpt from the Hussman Funds' Weekly Market Comment (6/15/09):

It is a very hard sell to expect a sustained recovery in debt-financed gross investment in an economy under strong deleveraging pressure. That's particularly true since the U.S. itself has not financed a penny of the growth in U.S. gross domestic investment in more than a decade – all of the growth has been financed by foreign capital inflows via a massive current account deficit. With government spending now drawing on those foreign savings to defend bank bondholders from losses, and a continuing need to shrink the current account deficit in the years ahead, gross domestic investment is likely to continue to be squeezed. We are in the midst of – and will continue to require – perhaps the largest adjustment in U.S. personal, corporate and government balance sheets that we will see in our lifetimes. This will be a very long slog. The outlook is not up, but very widely sideways.

It's nice to see consumer confidence rebound from its abysmal lows, but consumer confidence can largely be predicted from past changes in the stock market and inflation. A nice rally in stocks, coupled with soft inflation figures, has been helpful. But consumer confidence is not a useful predictive indicator of even consumer spending. Consumption is a very large, but also very stable part of GDP, and it is not the source of major variance. Indeed, except during the past year, we've never seen nominal consumer spending decline year-over-year even in recessions. The “permanent income hypothesis” of Modigliani and Friedman holds up very well in the data – investors simply do not significantly shift their consumption based on short-term fluctuations in income.

That said, it's a very negative signal that we've observed a decline in consumer spending over the past year – again – it's never happened before. The fact that it has in this instance suggests that consumers are anticipating a largely permanent downward adjustment in their overall spending ability. The lack of opportunity for continued mortgage equity withdrawals (a major source of consumer spending in recent years) explains part of that. The loss of investment and home values is another.

In typical recessions, unemployment tends to be a lagging indicator, and the employment figures themselves tend to move up and down roughly in concert with the overall economy. In the current downturn, however, the unusually high debt burden and precariousness of mortgages among households creates a dynamic that we don't usually observe. In the current cycle, as Ray Dalio of Bridgewater has correctly (in my view) pointed out, unemployment is likely to be a leading indicator of the economy. In an overleveraged economy, job losses can be expected to be followed by further delinquencies and mortgage foreclosures. While I don't expect that this will cause a violent feedback loop, I do believe that it is glib to assume that the employment markets and the U.S. economy are on a one-way track to improvement.

Comments

[user396040:]

This piece makes some excellent points. I do believe that we are in an unprecedented situation - what sailors call "uncharted waters." This piece correctly identifies some of the most important negative factors; on the positive side is an unprecedented expansive Federal Reserve monetary policy. I think it is extremely difficult to determine how it will net out; however, I am beginning to think that we will see surges of appreciation in various asset classes as the liquidity created by the Fed tries to find a home.

Jun 15 11:44 AM

[Larry House:]

Thanks for your insights, John. I agree with your cautionary tone, and thanks for not calling this a typical recession. I don't know how many recessions a lot of the "experts" have experienced first-hand, but I can tell you that over the past 50 years, there hasn't been one like this. We are in the perfect storm that comes only once per lifetime. I also agree with the largely sideways movement in stocks, but there could be more downside than many expect.

Jun 15 11:52 AM

[paulsjj:]

What do you expect? We have outsourced 67% of our energy production to foreigners. Our one-party government is going to double wind and solar from about 2% to 4% of our energy production in about 5 years...wow. Meanwhile the iron heel of our one-party government is on the neck of any new nuclear energy or domestic oil production. All this limits growth and jobs and increases the costs of everything. Cap and Trade will just add to the problems even more and build in slow to no growth into the basic structure of the economy. We elected them, we get what we deserve.

Jun 15 12:09 PM

[Fred Voetsch:]

"This will be a very long slog. The outlook is not up, but very widely sideways."


I agree in part but everytime I hear that talk about a sideways move or trading range I just laught. One thing we will NOT be in for a decade or two is a trading range.

At best we are in a trading range for the summer but the second half of 2009 does not look promising.

Jun 15 01:00 PM

[Dave Wrixon:]

Unemployment is not a leading indicator, it generally lags. However, in a prolonged downturn one metric feeds from another in a viscous circle. It is such viscous circles that Keysians seek to break, because they know that Unemployment can be self-reinforcing in a deep and prolonged downturn.

The problem is that borrow to squander actually destroys so much wealth that the net effect is transitory at best. There was of course a lot of talk about investment in infrastructure, but that has no immediate effect on poll ratings, and so therefore gets quickly sidelined by politicians.

Yes, we may be past the worst in terms of the speed of the downturn, but things have a long-way to go yet and the second leg of the W might resemble the first, meaning that the drop is a lot deeper than the immediate recovery.

Jun 15 01:55 PM

[Carl Spackler:]

Right On!


On Jun 15 01:55 PM Dave Wrixon wrote:

> Unemployment is not a leading indicator, it generally lags. However,
> in a prolonged downturn one metric feeds from another in a viscous
> circle. It is such viscous circles that Keysians seek to break, because
> they know that Unemployment can be self-reinforcing in a deep and
> prolonged downturn.
>
> The problem is that borrow to squander actually destroys so much
> wealth that the net effect is transitory at best. There was of course
> a lot of talk about investment in infrastructure, but that has no
> immediate effect on poll ratings, and so therefore gets quickly sidelined
> by politicians.
>
> Yes, we may be past the worst in terms of the speed of the downturn,
> but things have a long-way to go yet and the second leg of the W
> might resemble the first, meaning that the drop is a lot deeper than
> the immediate recovery.

Jun 15 04:16 PM

[Alphameister:]

I admire your work, John, and I agree that this is NOT a standard-issue recession and the BEST secular trend reasonably posited for US markets is sideways, but this idea of unemployment being a leading indicator is just a silly redefinition. Of course an increase in unemployment LEADS to further problems among other economic metrics, as is true in any recession, and perhaps that influence is more apparent in a severe recession such as this one, but a lagging indicator is one that turns down (or up in the case of unemployment) after the economy has begun to weaken and turns up (or down in the case of unemployment) after the economy has begun to strengthen. If this recovery is as weak as I expect it to be, employment will be a very lagging indicator this time around and there will be abundant talk of a job-less recovery in our future.

Jun 15 05:24 PM

[Fighting Yoda:]

"This will be a very long slog. The outlook is not up, but very widely sideways." - sideways? I think it is downward. We had extreme excesses and complete credit foolishness for more than a decade. These excesses will take time to clean up - no V or even a U - it would be protracted L. Consumer deleveraging would keep pressure on the economy - lot more job losses and home price drops to come.

Jun 15 06:39 PM

[robert99:]

I'm going with a ten year sideways slog. Good thing my longs are 20 year holds. I'm hoping for some serious downside action so I can add some new positions and add to my existing ones. I suspect I won't be disappointed...

Jun 16 01:13 PM