John Hussman: A Tale of Two Data Sets

Excerpt from the Hussman Funds' Weekly Market Comment (8/31/09):

The chart below, for example, presents nominal GDP growth in recent decades, as well as the amount of nominal GDP growth that has occurred over-and-above the amount of new government debt that has been issued. This essentially measures the amount of dollar-GDP growth that has occurred independent of federal deficit spending. You can see that much of the economic performance during the 1980's and during the period since 2002 has been accompanied by expansion in federal debt, though we did observe fairly strong intrinsic demand during much of the 1990's.

The present situation is clearly and profoundly different from any post-war period, and was already preceded by weak intrinsic demand. The Treasury has run a deficit in excess of 7% of GDP year-to-date to maintain a still-negative growth in overall GDP. The economic expansion we've enjoyed since 2002 has been peculiar in its dependence on debt finance. The same basic story holds if one includes mortgage equity withdrawals and other forms of debt expansion. This will not be an easy situation to solve with an increasing number of homes now “underwater” relative to their outstanding mortgages, and with job losses continuing (above expectations at 570,000 last week).

As John Mauldin noted this week “ We will be faced with a choice this fall and early next year. If you take away the government spending, the potential for falling back into a recession is quite high, given the underlying weakness in the economy. A few hundred billion for increased and extended unemployment benefits will not be enough to stem the tide.”

My impression is that if the recent downturn had been a standard post-war recession, many elements of market action – such as strong volume sponsorship – would have kicked in very early in the advance, as they historically have. That, coupled with less severe economic problems, might have allowed us to remove a much larger percentage of our hedge, as we did very quickly after the March 2003 low, when we removed 70% of our hedges. Market and economic conditions have not provided that evidence in this instance. So if, in hindsight, our economic difficulties are behind us by now, and we're off to the races, then it's clear that our measures missed an uncharacteristically large portion of the initial advance, and our concerns about economic fundamentals will have been misplaced.

On the other hand, if the broader structural problems with the economy – particularly the mortgage market – are still in place, as I believe they are, it is a dangerous leap of faith to assume that the market will be impervious to them and behave as it has during periods when we already know, with the benefit of hindsight, that the recession was over.

Comments

[Larry House:]

Thanks, John, for a clear statement of risk vs. reward. No one likes to hear that it is different this time, but it is. We have many serious obstacles ahead, and risky assets may be abondoned once again.

Aug 31 10:50 AM

[traden4alpha:]

Thanks for dissecting the deficit-pumped false-growth in GDP -- the recent use of borrowing from the future to finance the economy of today. But does this analysis go far enough? How much of recent GDP came from net consumer borrowing -- using inflated home equity and loose consumer credit to finance consumption. This seems to be missing from this analysis and other analyses that only look at the burgeoning level of public debt. Shouldn't one analyze the impact of all deficits and debts, both public and private, in creating the false appearance of GDP growth now and the high likelihood of lagging performance in the future?

Deficits and borrowing are not bad, per se, if they finance needed capital expenditures, new innovation, or productivity enhancements. Returns on borrowed funds can justify borrowing and contribute to real GDP improvements. But it's clear that the past decade has seen a large amount of consumer, corporate, and government borrowing that was squandered on short-term consumption, not long-term investment.

Aug 31 11:20 AM

[mplaut:]

OK. So it is clear that either the market may go up more although on the other hand it may go down.

Thanks a lot.

Aug 31 11:45 AM

[Up Yours SP500:]

"This will not be an easy situation to solve with an increasing number of homes now “underwater” relative to their outstanding mortgages, and with job losses continuing (above expectations at 570,000 last week)." Great insight John, but you also forget to mention the upcoming collapse of the commercial real estate market, I would be curious to see what the federal government will do then to save that market....any insight?

WSJ had a great article on commercial real estate:

finance.yahoo.com/real...

Aug 31 10:12 PM

[Davewmart:]

A very good article.
I do not agree with hose who are critical as it does not cover every aspect of the current situation, as this is impossible in a short article.
It does however provide fine analysis on the parts it is focussed on.
Overall it is not only clear that so far the present recession has tracked that of the 1930's with uncanny precision, including the present rally, but that the nature of the underlying problems in particular heavy indebtedness are much more similar to that event than any of the intervening recessions.
I expect any recovery to be equally difficult and protracted.

Sep 01 06:11 AM