John Hussman: Strenuously Overbought

Excerpt from the Hussman Funds' Weekly Market Comment (9/21/09):

My discomfort about strenuously overbought and moderately overvalued conditions overlaps with skepticism about the U.S. economic “recovery,” which appears to be nothing but an artifact of government spending, while intrinsic economic activity remains weak. Stimulus induced “strength” is unlikely to propagate because, as I've noted before, economic recoveries are invariably led by expansion in debt-financed forms of spending such as gross domestic investment and durable goods. These classes of spending tend to lead other forms of economic activity by nearly a year, and it is difficult to expect this in an environment of heavy continued deleveraging pressure. Rather than abating, foreclosures and mortgage delinquencies are setting further records (pressured even more by continued net job losses), and we have now hit the point where Alt-A and Option-ARM resets are beginning (after a lull in the reset schedule since March). We know that post-crash markets feature partial recoveries followed by a very extended period of sideways movement. To expect an entirely different result in this instance – to assume that this is a typical post-war recovery and that everything is back to normal – seems hopeful to say the least.

The percentage of bullish investment advisors now rivals that seen at the 2007 peak. Stocks are strenuously overbought. The S&P 500 is overvalued to the extent that we now expect just a 6.6% annual total return over the coming decade (a level that except for the period since the mid-1990's has corresponded more to bull market peaks than bases for sustained advances). Historically, such combinations of overbought, overvalued, overbullish evidence have generally been unrewarding, so we don't even need to consider special cases. However, recent (and in my view continuing) economic conditions are nothing if not a special case, and the historical parallel I am most concerned about is the one with the closest overlap to this one.

Here is a chart of the S&P 500 in weekly data. Note that the market easily and repeatedly breached the lower green bands during the decline, so we should not assume that these bands provide reliable guidance for buying or selling. The recent advance has moved the market the full distance from lower to upper bands, however, which typically does not go uncorrected.

The following chart may look the same as the above chart. But it is from April 1930.

The market recovered by an almost identical percentage following the 1929 crash, peaking in April 1930, after which it suffered a subsequent decline to fresh lows. The point here is not that the same outcome will necessarily follow in this instance, but that we would be remiss not to consider the fact that investors were equally cheerful in early 1930, when the front page of the Wall Street Journal featured an article entitled “A Turn of the Tide Near” assuring investors: "It cannot be imagined that the wholesale failures and interest defaults characteristic of earlier depressions will now be repeated. Confidence in our banking system wholly precludes the money panics of former eras."

Comments

[Joseph L. S...:]

The similarity to 1930 today is that any confidence in our bankers, brokers, and "banking system" is equally ill-founded.

The dissimilarity is that there are scores more ways today to turn taxpayers upside down and shake them until all the money falls into the hands of government, which can then use fiscal stimulus -- both printing and spending -- to keep the ship (barely) afloat until the crew -- that's those of us who actually produce something -- starts bailing the excesses by forming new small banks that actually loan money to small businesses.

As I used to tell my staff after I left my Regional position and became part of "home office," never forget that we corporate types (like Big Government) are overhead, they (the branch offices where profits are generated, but think "taxpayers" for this analogy) are revenue.

We'll get through this, though the long-term cost may be onerous...

Sep 21 10:52 AM

[LT Trader:]

Whenever someone tells you "this time, it's going to be different" with respect to the markets when they are too far overbought or oversold, it usually isn't the case.

Hopefully, we won't be re-entering the abyss, but I also don't expect returns to be too fantastic moving forward since such a large move has occurred (around 60% in S&P 500 and over almost 90% in small-cap value indices). If eternal optimism keeps continuing, just continues to lower future expect returns and will result in another nasty downturn.

Sep 21 03:05 PM

[PearlCreek:]

I am usually a fan of Dr. John. This is horrendously shoddy work for him.

Sep 21 03:12 PM

[Mr. Big:]

I think, every now and then, this type of published work is useful in invoking thought. The thought that we are not out of the woods yet... Which we aren't.

Important points are made here. This "recovery" in the markets is supported by unprecedented government stimulus in combination with an extremely accommodative monetary policy. In other words, the economy is on life support. And the breathing machines are running out of batteries (evidence in point: the declining value of the US dollar).

The majority viewpoint is that the "recovery" in the economy will be more L-shaped, meaning that growth over the medium term will be pretty much negligable or feable at best. This L-shaped recovery assumes that the stimulus and the easy monetary policy will always be there. However, at some point (probably in the near future), the government and the Fed will be forced to make a decision: 1) remove the stimulus and push the economy into an even worse recession, 2) keep the stimulus in place and decimate the USD....which may eventually lead to inflation/hyperinflation, 3) something between the two. It's going to be a tough decision. Especially in the backdrop of higher energy prices and, more importantly, the healthcare issue. No matter how it's spun, the healthcare policy will lead to higher taxes for everyone....significantly so. Even the best case scenarios are scary.

So if the economy does plunge into Recession Part II, it's not going to be easy to get out of anymore. Stimulus is tapped out. Fed intervention maxed out. States and municipalities are out of money. Taxes increasing for the people. Unemployment already at high levels. Energy costs rising.

God help us all if we were ever to get a double dip recession.

Sep 21 04:50 PM

[untrusting ...:]

Have read John Hussman and his staff commentary for quite awhile now, and it always provides an interesting, well-written, and factually supported basis for his opinion and why he is investing his funds the way he is.

Just read the following Hussman recent articles and they are well worthwhile reading and considering

1) www.hussmanfunds.com/w...
This article shows some of the worst times ever to invest (big losses) and the conditions that were present at the worst investment times in history. Several of them are clearly present in this "recovery rally". More big red flags for the permabulls.

2) www.hussmanfunds.com/r...
This article shows how the volume in this "recovery rally" is totally abnormal vs. any previous rally in market history and thus should serve as a hugh warning to permabulls. This is probably one of the main reasons why Hussman has little believe in this rally and probably justifably so, given the facts presented in this article.

We think Hussman is one of the most astute, factually based, honest, professional big-time money managers out there today. And if Hussman is ultra cautious at this point, we believe that the small retail investor should at least seriously consider his messages as they could well save them a boatload of money going forward. Hussman is a man well worth listening to.

Sep 21 09:52 PM