Market Insanity Reigns
Dow Jones
Breaks Through
30,000
Hypervaluation and the Option Value of Cash
John P. Hussman, Ph.D.
President, Hussman Investment Trust
December 2020
Somebody always pays when the house of cards collapses, and it’s usually the public – through a combination of bailout costs and employment losses. As the housing bubble was emerging, I wrote, “The real question is this: Why is anybody willing to hold this low interest rate paper if the borrowers issuing it are so vulnerable to default risk? That’s the secret. Much of the worst credit risk in the U.S. financial system is actually swapped into instruments that end up being partially backed by the U.S. government. These are held by investors precisely because they piggyback on the good faith and credit of Uncle Sam.” The outcome of that episode of yield-seeking speculation was the deepest financial crisis since the Great Depression.
Investors have become so intolerant of the frying pan of zero interest rates that they’re now only too willing to launch themselves into the fire.
As risk-aversion has abated, and investors look toward a post-pandemic future, speculation has now driven our estimate of prospective 12-year S&P 500 average annual nominal total returns to -3.6%.
Stock prices haven’t just priced in a recovery. They’re already beyond where they were before the pandemic. Indeed, we currently estimate that the average annual nominal total return of the S&P 500 is likely to lag the returns of Treasury bonds, by fully -4.6% during the coming 12-year period. So much for the notion of an “equity risk premium.”
The perpetual speculation of Wall Street relies on confidence that every market retreat will be met by another Federal Reserve stick-save. Yet all of these stick-saves by the Federal Reserve defer a financial collapse only by amplifying its eventual size.
Presently, I expect that the completion of this market cycle is likely to involve a loss in the S&P 500 on the order of 65-70%.
I realize, of course, that this sounds insane. The problem is that this projection is fully in line with a century of evidence, and is consistent with the extent of market losses that would be run-of-the-mill given present valuation extremes. Indeed, the only reason that the S&P 500 did not lose a similar amount during the 2000-2002 collapse (though the tech-heavy Nasdaq 100 lost a weirdly precise -83%) is that the market did not actually reach its valuation norms by the end of that cycle. Instead, the market went on to breach its 2002 bear market low during the 2007-2009 collapse.
DYI: First of all I agree with Hussmann's estimated average annual return and the decline calculation back to the markets mean of Shiller PE 16. Be aware markets can and have routinely dropped below their average valuation for years [see chart below]. What if over the next 10, 12 or 15 years from now valuation drop below Shiller PE of 10? What would your estimated average annual rate of return for common stocks over the next 12 years? Drum roll please…Go to Money Chimp calculator your answer is – negative 8.37%!
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