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Wrecking Ball

John Hussman profile picture
John Hussman

As of last week, the valuation measures that we find most strongly correlated with actual subsequent 10-12 year S&P 500 total returns in market cycles across history now range between 140-170% above their pre-bubble norms. While valuations at those pre-bubble norms are closely associated with prospective S&P 500 total returns in the range of 10% annually, valuations at current levels are associated with expected returns of about -2.5% annually on a 10-year horizon, and roughly zero on a 12-year horizon. Nearly every market cycle in history has brought these valuation measures back toward their historical norms, and no cycle (even those associated with quite low interest rates) has failed to bring them within about 25% of those norms. Assuming that valuations do not breach historical norms (as they did even in the most recent market cycle), the associated downside expectation for the S&P 500 over the completion of the current market cycle now runs between -48% and -63%.

While it's reasonable to believe that low interest rates justify higher than normal valuations, and lower-than-normal expected returns for stocks, we doubt that investors are comfortable with zero or negative returns being their definition of "justified." What's really happening is what always happens late in a speculative cycle, which is that the extrapolation of the recent half-cycle advance encourages investors to believe that the stock market simply "pays" high returns as if they were interest payments. It generally does not enter the speculator's mind how strongly the ratio of market capitalization to GDP is correlated with actual subsequent market returns (though we prefer to use corporate gross value added including estimated foreign revenues, which creates a proper apples-to-apples measure). Sustained capital gains in the broad stock market, materially in excess of nominal economic growth, are typically borrowed from the future and repaid over the completion of the

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John Hussman profile picture
Dr. John Hussman is the president and principal shareholder of Hussman Econometrics Advisors, the investment advisory firm that manages the Hussman Funds ( http://www.hussmanfunds.com). He holds a Ph.D. in economics from Stanford University, and a Masters degree in education and social policy and a bachelors degree in economics from Northwestern University. Prior to managing the Hussman Funds, Dr. Hussman was a professor of economics and international finance at the University of Michigan. In the mid-1980's, Dr Hussman worked as an options mathematician for Peters & Company at the Chicago Board of Trade, and in 1988 began publishing the Hussman Econometrics newsletter. Virtually all of Dr. Hussman's liquid assets are invested in the Hussman Funds. Note: Dr. Hussman is not an active contributor to Seeking Alpha; rather, SA editors excerpt regularly from Dr. Hussman's public commentary.

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