John Hussman: Investors Haven't Fully Discounted Reality of Recession

Excerpt from the Hussman Funds' Weekly Market Comment (9/7/08), which this week is Hussman Funds 2008 Annual Report.

With regard to the broader stock market, my impression is that investors still have not fully accepted or discounted what I view as the fact of recession. Unfortunately, credit spreads continue to widen, suggesting growing default risk beyond just the financial sector (the Moody's Baa/Aaa credit spread surged to a 25-year high last week), and job losses are increasingly spread broadly across industries. The level of economic discomfort certainly increased with Thursday's jump in jobless claims and Friday's weak employment report, but it was very noticeable that the selloff in the S&P 500 quickly halted at the same level as the closing low of the July decline. Investors appeared to believe (at least temporarily) that the prior closing low represented a good buying point.

For my part, I'm neither compelled nor unduly distressed by current valuation levels. Though valuations (particularly on the basis of normalized earnings) are still richer than we typically observe at bear market lows, they are gradually improving. For that reason, if we can get some distance below the recent trading range on legitimate recession, profit and credit concerns, we may have the opportunity to establish some amount of market exposure at those lower levels, with a reasonable expectation of recovering toward current levels on a subsequent recovery. In other words, we aren't inclined to accept market exposure at present, because the outlook for a sustained advance from this starting point isn't particularly strong. But we would be inclined to gradually increase our market exposure some distance below these levels, because a recovery back to this area (say, in a bear market rally or eventual bull market) might then be reasonable or even likely.

...

Ideally, the present bear market decline will end at a much better valuation trough than the 2000-2002 bear market established. One of the reasons that the initial portion of a bull market produces such powerful returns is that new bull markets have historically taken the normalized price/earnings ratio on the S&P 500 from deeply depressed levels back toward “known values.” Bear markets have regularly troughed below 11 times prior peak earnings, with an average closer to 9 times prior peak earnings, and sometimes below a P/E of 7, as we saw in 1974 and 1982. By contrast, the 2002 bear market low was established at a much higher multiple (about 15), which is why the most recent bull market produced only one annual gain exceeding 20% for the S&P 500, with relatively tepid returns over the complete cycle (the 5-year total return on the S&P 500 is currently just under 6% annually).

Comments

[Schweizer:]

And today's PE is mid 20's!

SP500 at 600 here we come. $50 earnings at 12 PE.

2008 Sep 08 11:32 AM

[DaveW:]

$harky, we (and yourself it seems) all pat you on the back, good job. Knowing your target audience is the most important part of writing any article. Did you notice the target audience were investors, not traders? Hope you're getting ready to go short, if you really are a good trader...

2008 Sep 08 12:49 PM

[whidbey:]

Just how low must it go to reach the p/e differentials suggested? I was guessing that 9700 dow and 1070 s&p seemed downside targets, but I think John sees some else, something more volatile. But if earnings slip, and they will, then the equation become and unknown quadratic. What, if anything does John mean?

2008 Sep 08 05:38 PM

[Steven Hansen:]

"the outlook for a sustained advance from this starting point isn't particularly strong"

i agree. further there is no economic upturn on the horizon - and no fundamentals for a strong revival which would warrant exposure in the market at these levels.

2008 Sep 09 12:34 AM