- John Hussman says he expects stocks to end the bear market down 50-70%.
- Hussman said while investor sentiment is bearish, positioning is still too bullish.
- The S&P 500 is down around 24% this year.
According to Hussman, the president of the Hussman Investment Trust who called the 2000 and 2008 crashes, the most reliable valuation measures for predicting future returns are still around levels seen during the dot-com bubble over two decades ago.
That’s problematic for investors for a couple of reasons, Hussman said in a commentary this week.
For one, interest rates are rising quickly as inflation remains elevated and the Federal Reserve tightens monetary policy at the most aggressive pace since 1994. This means increased competition for risk assets like stocks — competition that hasn’t been there for over a decade. (Why invest in volatile stocks when you can get a risk-free 4% yield from a 10-year Treasury note?)
Generally falling bond yields since the Great Financial Crisis have meant a greater willingness among investors to accept higher valuations in stocks. Now that yields are becoming more attractive, that willingness to accept higher valuations is waning.
Second, Hussman says his proprietary gauge on “market internals” is currently unfavorable. In other words, investors are spooked and less willing to take risks at the moment.
But according to Hussman, this risk-aversion has yet to show up in investor positioning. According to recent American Association of Individual Investors surveys, investors still have a 64.5% allocation to equities in their portfolios despite high valuations and rising yields. Hussman said this is above average, and pointed out that at the market bottoms in 1990, 2002, and 2009, that level was 40%.
“Put simply, investors are clearly becoming uncomfortable, but in practice, they continue to defend the hill of extreme valuations, in the apparent belief that whatever risk remains must be short-term in nature,” he said.
Hussman said the market’s rally between mid-June and mid-August was one what he thinks will be multiple bear market rallies on the way down to the bottom.
“The way that bubbles unfold into preposterous losses – 89%, 82%, 50%, 55%, and I expect this time between 50-70% – is through multiple periods of decline and even free-fall, punctuated by fast, furious ‘clearing rallies’ that offer hope all the way down,” Hussman said.
He continued: “By the time investors experience the second or third free-fall – and we’ve hardly experienced the first one yet – the psychology of investors is not ‘this is the bottom’ – but rather, ‘there is no bottom.'”
Hussman’s track record — and his views in context
Hussman has plenty of company in his call for stocks to go lower. Some of the biggest names on Wall Street said in September that the market still has substantial downside ahead.
Bridgewater Associates Founder Ray Dalio said he higher risk-free yields in the Treasury market and and damage to corporate earnings — both thanks to Fed tightening — would drag down stocks another 20%.
Jeremy Grantham, the founder of GMO, said valuations are still too high, and reached “superbubble” status late last year, rising 2.5 standard deviations from historical norms. In each of the last three “superbubble” instances of the last century, stocks fell at least 50%. Grantham told Reuters he expects stocks to end the bear market down at least 37%.
Scott Minerd, the CIO at Guggenheim Investments, also said valuations are too high given where inflation is, and that the market should fall another 20% from September 8 until mid-October. Since September 8, stocks are down around 9%.
A number of Wall Street strategists — like Bank of America’s Savita Subramanian, Morgan Stanley’s Mike Wilson and Goldman Sachs’ David Kostin — have also said they anticipate the S&P 500 to fall to a range around 3,000-3,600 (depending on how hard the economy is hit by monetary tightening) in the months ahead before rebounding. The index sits around 3,650 currently.
All of them see inflation coming down, and the Federal Reserve pivoting back to more dovish policy — or at least putting a pause on their hawkish policies.
“It should be increasingly probable that the next months could see some dovish tilt by the Fed,” Kolanovic said in a note this week.
Whether or not the Fed pivots to dovish policy this winter is one of the biggest questions in markets right now. Such a move is dependent on how quickly inflation falls and how well the the job market holds up in the months ahead.
The Consumer Price Index, a main measure of inflation, hit 8.3% in August, down from 8.5% in July and 9.1% in June. The Fed has said their goal is to bring it back to 2%.
The labor market remains strong with unemployment at a historically low 3.7%. Job openings also remain relatively elevated, rising again in August after falling in the second quarter.
According to a Bank of America analysis of second-quarter corporate earnings calls, however, mentions of layoffs are starting to spike like they have in prior recessions.
For the uninitiated, Hussman has repeatedly made headlines by predicting a stock-market decline exceeding 60% and forecasting a full decade of negative equity returns. And as the stock market had continued to grind mostly higher, he persisted with his doomsday calls.
But before you dismiss Hussman as a wonky perma-bear, consider again his track record. Here are the arguments he’s laid out:
- He predicted in March 2000 that tech stocks would plunge 83%, then the tech-heavy Nasdaq 100 index lost an “improbably precise” 83% during a period from 2000 to 2002.
- Predicted in 2000 that the S&P 500 would likely see negative total returns over the following decade, which it did.
- Predicted in April 2007 that the S&P 500 could lose 40%, then it lost 55% in the subsequent collapse from 2007 to 2009.
However, Hussman’s recent returns have been less-than-stellar. His Strategic Growth Fund is down 43% since December 2010, though it’s up 6% in the last 12 months. The S&P 500, by comparison, is down 16% over the past year.
The amount of bearish evidence being unearthed by Hussman continues to mount, and his calls over the last couple of years for a substantial sell-off are proving accurate so far. Sure, there may still be returns to be realized in this market cycle, but at what point does the mounting risk of a larger crash become too unbearable?
That’s a question investors will have to answer themselves — and one that Hussman will clearly keep exploring in the interim.