John Hussman: Stocks to Lead the Economy Lower

by: John Hussman

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

The recent bull market has enjoyed an above-average duration, and hasn't produced even a 10% correction in 3 ½ years. Yet except for low-quality and small-cap stocks, only the first year (2003) of the bull market was satisfyingly “bullish” for stocks. Since April 2004, the S&P 500 index has produced an annual total return of only about 6.5% - nothing like the 20-30% annual returns that are typical of the “bull market” portion of a cycle. Needless to say, those low returns are largely related to the persistent over-valuation of the market, which was never cleared during the 2000-2002 plunge. The next substantial decline will, I expect, give the market a better valuation-footing from which to produce durably high returns...

It's useful to remember that stocks generally turn lower before the economy, with a lead-time of about 6 months. That may very well be the window we've entered here. On the economy, the most recent data on housing-starts continues to confirm a downturn in housing... Meanwhile, a few writers including Floyd Norris of the Wall Street Journal and Jim Stack of Investech have noted that new car sales are now down on a year-over-year basis. Norris notes that declines in new car sales by more than -2% on a year-over-year basis have always been followed by recessions. The latest year-over-year figure is -2.4%.

In terms of price/volume behavior, Lowry's notes that the market's recent bounce hasn't been driven by measurably increased buying demand, but rather by a “backing off” of sellers. That's not characteristic of sustained market advances. The major indices remain extended in an overbought condition, which in unfavorable market climates tends to give the markets a downside bias. Still, it's important to remember that even unfavorable market climates allow for short-term advances – it's just that the average return/risk profile in such climates tends to be unfavorable. In bonds, the market climate remained characterized by modestly unfavorable valuations and relatively neutral market action. Later this week, we'll get a good amount of new data on revised GDP and PCE [Personal Consumption Expenditures] inflation. The market has been extremely focused on the smallest surprises in this sort of data, so the market's response – positive or negative – may very well exceed the true statistical importance of the actual data.