John Hussman: Don't Be Surprised By Stagflation Ahead

by: John Hussman

Excerpt from fund manager John Hussman’s weekly essay on the US market:

1. Profit margins are likely to contract in the next few years...

2. The U.S. stock market is likely to struggle. While the current price/earnings ratio for the S&P 500 (net trailing earnings) is a historically above-average but seemingly benign 17.6, it's notable that the current P/E would be approximately 25 on the basis of normalized profit margins. Alternatively, the current multiple of 17.6 should be evaluated relative to the norm of just 9 times earnings that has historically prevailed when earnings have been near the top of their long-term growth channel.

3. The U.S. economy is likely to experience weak growth in the coming quarters. Given the collection of evidence already in hand, at the point that the ISM Purchasing Managers Index drops below 50, or the 6-month growth in total non-farm employment declines below 0.5%, the likelihood of an oncoming recession will rise to near-certainty.

4. The U.S. current account deficit is likely to contract in the quarters ahead, but only because of a decline in foreign capital inflows. This is likely to result in flat or declining U.S. domestic investment, particularly in the housing sector...

5. Inflation is likely to remain a persistent “structural” problem, rather than a “cyclical” one that will go away at the first hint of economic slowing. Meanwhile, U.S. nominal interest rates will most likely fail to track economic growth lower...

6. The U.S. dollar is vulnerable. Foreign buying of U.S. Treasuries has to-date been the chief “flow” factor supporting the value of the U.S. dollar, and relatively attractive U.S. real interest rates have been the chief “fundamental” factor. The current withdrawal of these factors could provoke a dollar crisis (substantial weakness in the U.S. dollar and rising import price pressures). Meanwhile, weaker economic growth will probably be sufficient to keep the Fed from tightening in order to support the dollar.

In short, we should not be surprised to observe stagflation, falling stocks, weak profits, flat bonds, and a dollar crisis in the months ahead.