John Hussman: Don't Bet on the Markets Until They Outpace T-bills

 |  About: SPDR S&P 500 Trust ETF (SPY)
by: John Hussman

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

It's not unusual for people to magnify trivial differences when the stakes themselves are trivial. Call it a scarcity mentality. My impression is that this sort of mentality is present in the financial markets here.

Over the past two-and-a-half years, returns for both Treasury bonds and the S&P 500 have been well below-average. Interest rate levels are still muted despite wage pressures and other inflationary indications. With no persistent benefit from capital gains, fixed income investors have been stretching for yield, allowing risky corporate bonds to trade at nearly the same yields as default-free Treasuries. In effect, investors are taking higher risks precisely because the stakes are so low. Of course, the potential negative outcomes could substantially exceed the extra interest margin these investors are receiving, but it's historically been the nature of junk bond investors to stand around in smoky rooms until they actually see the fire.

From its intermediate peak on March 5, 2004, the S&P 500 has earned scarcely more than the 3-month Treasury bill yield. Yet every trivial advance to a temporary peak is hailed by analysts and floor reporters as if the stock market is “breaking out” and soaring without bounds.

The recent inflation data is another area in which investors are magnifying the trivial. For the most part, the excitement about “moderating inflation” in recent weeks has been based on the thinnest “positive” surprises, generally on the order of rounding error...

Investors seem willing to take high risks because those risks seem the only alternative to still modest-yielding Treasury bills. They also seem willing to charge ahead on even the smallest relief in inflation data, in hopes that Fed hikes are finally behind us... The likelihood of durable market gains over-and-above T-bill yields is very slim.

Our measures of market action remain unfavorable, despite the recent rally in the S&P 500 and even the NYSE advance-decline line. As Lowry's also notes, “the rally had the earmarks of a normal short-term, low-volume, selective rally attempt in a bear market. Rallies occurring on diminishing volume are always highly suspect”... Without the help of favorable internal market action, broad market risk has neither speculative merit nor investment merit here.

Think of it this way. Suppose that there was a high 80% chance that the market will rise 10% over the coming year, and just a small 20% chance that it will decline 15% over the coming year. Sound like good odds? Well, given those odds, the expected return would be [.80(10%) + .20(-15%) = ] 5%, which is the same as you'd get in risk-free T-bills. A risk-averse investor wouldn't take the bet.