John Hussman: What Happens When No One Is Left to Hold the Bag?

Excerpt from fund manager John Hussman's weekly essay on the U.S. market:

In the microscopic focus on day-to-day fluctuations in the market, it is easy to overlook how unusual -- specifically, unusually unfavorable -- current market conditions are from a long-term historical perspective. The S&P 500 is currently at 18 times record net earnings (never mind that these earnings are also on record profit margins, so that the market is also implicitly pricing in permanently high expectations for these margins -- on normalized margins the P/E would be above 25). Bond yields are rising. Price trends remain strenuously overbought. The Investor's Intelligence figures put advisory bulls at 53.3%, with bears at an unusually low 18.9%.

If we look historically at points where similar conditions held true, we find April 1965 (swiftly followed by a market plunge), December 1972 (the beginning of the '73-74 decline which took stock prices down by half), August 1987 (no comment), July 1999, December 1999, March 2000 (all three of the latter followed by separate drops of 9-16%), and a few instances closely surrounding those dates.

It's notable that while we have not observed even a 10% correction since 2003, the corrections that we have observed also had their origins in (somewhat milder) combinations of overbought conditions, high bullishness, and rising yields (either Treasury bond yields or Treasury bill yields)...

It's also important to recognize how strenuously overextended international markets are at present. This can only exaggerate the impact of any shift in the preference of investors away from risk. With valuations rich, stock markets almost universally overbought, bullishness extremely high, and mutual cash levels the lowest on record, it seems very much like everybody is in because they expect everybody to get in, not knowing that everybody is already in...

The question is whether the speculators holding stocks here (unhedged) will encounter others willing to lift those stocks from their hands at higher prices, and what happens if they don't.

Comments

[Paul Meisel:]

Of course this looks at the market as an aggregated whole.

The PE of my portfolio is about 15....

2007 Jun 25 08:14 AM

[k_denninger:]

P/Es when the "E" is based on one-time FX gains is fanciful at best.

When its based on inflated margins that historically are likely to regress to the mean, its even worse.

Rhetorical question: What purpose does a P/E ratio serve when the "E" is cooked?

I suspect the author knows the answer... as do I.....

2007 Jun 25 09:20 AM

[Paul Meisel:]

Do you really think that the majority of the S+P 500 cooked the books? Or that everybody's margins are high, when 20% of the index (financials) are trying to survive an inverted yield curve, and the construction and building supply industry is depressed?

I am not quarreling that some stocks may be overpriced. Just not all of them.

2007 Jun 25 11:00 AM

[ari5000:]

Hussman's been calling for an end to this rally since when? September?

He's underperformed the indexes for at least the last 2 years.

Anyone can write a blog entry. I think people who can make money for their clients is worth listening to. What's Hussman doing that an Index fund can't do a whole lot better?

If he knows so much about cycles -- he should be betting big right now and then shorting hard when it ends. But he has no idea when cycles begin or end and he certainly can't see the impact of an emerging China, India, and Brazil have on the global economy...

He's an intellectual guy but that doesn't make for good trading/investing.

2007 Jun 25 03:36 PM

[Jeopardy:]

"never mind that these earnings are also on record profit margins, so that the market is also implicitly pricing in permanently high expectations for these margins -- on normalized margins the P/E would be above 25"

I think this is a valid argument. If we are seeing the peak earning, then P cannot go up much w/o E further expanding.

BTW, he is running a long/short fund with an important goal of reducing volatility.

2007 Jun 25 09:34 PM

[Paul Meisel:]

Goals are important. In a long/short fund, being long the undervalued and short the overvalued, assuming you can identify them reasonably well, makes sense.

What I have not understood about many of his posts is that they usually focus on the overvalued without any mention of the other side. That may just be his personal interest -- or perhaps he is cautioning index fund investors.

2007 Jun 26 08:56 AM