John Hussman: Financial Markets 'At a Critical Point'

Excerpt from fund manager John Hussman's weekly essay on the U.S. market (11/19/07):

As Jim Stack of Investech recently noted, a market drop of even the recent -7.1% following a third discount rate cut has happened only 3 times in the past 80 years: February 1930, July 1982, and March 2001. In each case, the economy was already in recession (or worse).

Those are not the kind of odds that make one feel comfortable in today's uncharted waters. I should add that while the 1982 instance was different than the others (in that it was followed by very strong market returns), this is because the S&P 500 price/peak earnings multiple in July 1982 was already less than 7....

The level of my concern should (and is intended to) strike long-time readers of these comments as unusually high... there are occasionally situations where the set of conditions becomes so extreme that we observe them only before significant shocks. In the past few months, I've emphasized two such "Aunt Minnies" - one related to stock market risk, and one related to recession risk. Accordingly, I've used the term "warning" in recent weeks, which I don't take lightly.

A Who's Who of Awful Times to Invest

Expecting A Recession

In short, the financial markets are at a critical point. It's possible that investors will somehow adopt a fresh willingness to speculate, but my impression is that in the weeks ahead, investors will be forced to recognize that recession risk has tipped. That's not to say that this realization will produce one-way market movements. Seasonal factors tend to buoy the market a few trading days before holidays and a few days around the turn of each month, and as I noted last week, oversold conditions lend themselves to "periodic short squeezes and spectacular but short-lived rebounds"...

So we will almost certainly observe advances driven by investors frantic to "buy the dip" and "catch the rebound." Overall, however, the return/risk profile on both stocks and the economy as a whole appear increasingly lopsided toward bad outcomes.