Last week ended with the cackling hens on CNBC and the spokesmodels on Bloomberg bloviating about the temporary pothole on the road to riches. They assured their few thousand remaining viewers the 11% plunge in the stock market was caused by China and the communist government’s direct intervention in their stock market, arrest of a brokerage CEO, and threat to prosecute sellers surely cured what ails their market. The Fed and their Plunge Protection Team co-conspirators reversed the free fall, manipulating derivatives and creating a short seller covering rally back to previous week levels. The moneyed interests are desperate to retain the appearance of normality and stability, as their debt saturated system teeters on the verge of collapse.

John Hussman’s weekly letter provides sound advice for anyone looking to avoid a 50% loss in the next 18 months. The market has been overvalued for the last three years and now sits at overvaluation levels on par with 1929 and 2000. The difference is that fear has been overtaking greed in the psyches of traders. The average Joe isn’t in the market. Only the Ivy League MBA High frequency trading computer gurus are playing in this rigged market. The 1,100 point crash last Monday is what happens when arrogant young traders, fear and computer algorithms combine in a perfect storm of mindless selling. Suddenly the pompous risk takers became frightened risk averse lemmings.

The single most important thing for investors to understand here is how current market conditions differ from those that existed through the majority of the market advance of recent years. The difference isn’t valuations. On measures that are best correlated with actual subsequent 10-year S&P 500 total returns, the market has advanced from strenuous, to extreme, to obscene overvaluation, largely without consequence. The difference is that investor risk-preferences have shifted from risk-seeking to risk-aversion.

If there is a single lesson to be learned from the period since 2009, it is not a lesson about the irrelevance of valuations, nor about the omnipotence of the Federal Reserve. Rather, it is a lesson about the importance of investor attitudes toward risk, and the effectiveness of measuring those preferences directly through the broad uniformity or divergence of individual stocks, industries, sectors, and security types. In prior market cycles, the emergence of extremely overvalued, overbought, overbullish conditions was typically accompanied or closely followed by deterioration in market internals. In the face of Fed induced yield-seeking speculation, one needed to wait until market internals deteriorated explicitly. When rich valuations are coupled with deterioration in market internals, overvaluation that previously seemed irrelevant has often transformed into sudden and vertical market losses.

With corporate profits falling, margin debt at all-time highs, the Fed preparing to raise rates, China’s fake economic system imploding, currency wars breaking out across the globe, emerging markets in turmoil, oil dependent countries in the Middle East seeing budgets go deeply in the red, Greece and the other insolvent southern European countries nearing collapse and tensions rising between Russia, Europe and the U.S., there is plenty to fear in this central banker created debt bubble world. History teaches us this isn’t over. It’s only just begun. The bubblevision assertions that the worst is behind us is false. They will insist all is well until you’ve lost half your net worth. When fear overtakes greed, neither monetary easing, propaganda, nor acts of desperation by politicians, government bureaucrats, or central bankers will turn the tide.

It may not be obvious that investor risk-preferences have shifted toward risk aversion. It’s certainly not evident in the enthusiastic talk about a 10% correction being “out of the way,” or the confident assertions that a “V-bottom” is behind us. But a century of history demonstrates that market internals speak louder than anything else – even where the Federal Reserve is concerned. Why did stocks lose half their value in 2000-2002 and 2007-2009 despite aggressive and persistent monetary easing? The answer is that monetary easing doesn’t reliably support speculation when investors have turned toward risk aversion, as indicated by the state of market internals.

Why has the market become much more vulnerable to vertical losses since last summer? Because market internals have turned negative, indicating that investors have subtly become more risk averse, removing the primary support that has held back the consequences of obscene overvaluation. If the Fed is going to launch QE4 and QE5 and QE6, or if zero interest rate conditions are going to support speculation as far as the eye can see, those policies will only have their effect on stocks by shifting investors back toward risk-seeking, and the best measure of that shift will be through the observable behavior of market internals.

If the powers that be are this panicked with the market only off 6% from its all-time high, imagine how they’ll react when this turns into a route on par with the plunge in the Chinese markets. The average person on the street was worried early last week, but they mindlessly just regurgitated the mantra preached to them by MSM talking heads and Wall Street investment shills about long-term, blah, blah, blah. They acted the same way in 2007 through 2009, as their retirement funds were obliterated. The fact is that stocks are extremely overvalued and are going to fall, whether the moneyed interests like it or not.

It’s important to recognize that the S&P 500 is down only about 6% from its record high, while the most historically reliable valuation measures are double their historical norms; a level that we still associate with expected 10-year S&P 500 nominal total returns of approximately zero. We fully expect a 40-55% market loss over the completion of the present market cycle. Such a loss would only bring valuations to levels that have been historically run-of-the-mill. Investors need not expect, but should absolutely allow for, a market loss of that magnitude. If your investment portfolio is well-aligned with your actual risk tolerance and the horizon over which you expect to spend the funds, do nothing. Otherwise, use this moment as an opportunity to set it right. Whatever you’re going to do, do it. You may not get another opportunity, and if you’re taking more equity risk than you wish to carry over the completion of this cycle, you still have the opportunity to adjust at stock prices that are close to the highest levels in history.

How many Boomers or Gen Xers are prepared for 0% returns on their 401ks over the next ten years, with a 50% plunge thrown in for good measure? This market pullback is a drop in the proverbial bucket. Everyone should be using this dead cat bounce as an opportunity to get out of the market. But most will not heed Hussman’s advice. Their cognitive dissonance is too overwhelming.

The chart below offers a good idea of how little conditions have changed in response to the recent market pullback. The blue line shows the ratio of nonfinancial market capitalization to corporate gross value added, on an inverted log scale (so that equal movements represent the same percentage change). The slight uptick at the very right hand edge of the chart is barely discernable. That’s the recent market selloff. Current valuations remain consistent with expectations of zero nominal total returns for the S&P 500 over the coming decade.

The Fed is now nothing more than a helpless bunch of academic theorist bystanders as they already have interest rates at zero and have poured $3 trillion down the drain in their fruitless Keynesian effort to revive this zombie economy. Low interest rates didn’t work and they will not avert the coming stock market collapse.

Yes, low interest rates may encourage investors to drive stocks to extremely high valuations that are associated with low prospective equity returns. We certainly believe that as long as investor preferences are risk-seeking (as we infer from market internals), monetary easing and QE can encourage yield-seeking speculation that drives equities to recklessly extreme valuations. The point is that once valuations are driven to those obscene levels, low interest rates do nothing to prevent actual subsequent market returns from being dismal in the longer term. The low subsequent returns are baked in the cake.

Now for the money quote. Market crashes happen in stages. After an initial plunge, a recovery bounce occurs but fails to reach the pre-plunge levels. And then the bottom falls out. 

As I noted early this year (see A Better Lesson than “This Time Is Different”), market crashes “have tended to unfold after the market has already lost 10-14% and the recovery from that low fails.” Prior pre-crash bounces have generally been in the 6-7% range, which is what we observed last week, so I certainly don’t see that bounce as having removed any of our concerns. We remain extremely alert to the prospect for much more extended market losses.

Despite the brave talk from the buy and hold crowd, no one is prepared for a 50% loss over an 18 month horizon. These are the people who will hold until the market has already fallen by 30% and then panic. It has paid to be reckless and foolish over the last three years. It’s this same reckless attitude that brought down the dot.com day traders in 2001, house flippers in 2006, and subprime derivative gurus in 2008. Rational, risk averse, clear minded people need to bail out of the stock market now. It may be your last chance.

Again, if your portfolio is well aligned with your risk-tolerance and investment horizon, given a realistic understanding of the extent of the market losses that have emerged over past market cycles, and may emerge over the completion of this cycle, then it’s fine to do nothing. Otherwise, use this opportunity to set things right. If you’re taking more equity risk than you can actually tolerate if the market goes south, setting your portfolio right isn’t a market call – it’s just sound financial planning. It’s only fun to be reckless if you also turn out to be lucky. Market conditions are now more hostile than at any time since the 2007 peak. If you want to be speculating, and you can tolerate the outcome, then you’re not taking too much equity risk in the first place. But it’s one or the other. Can you tolerate a 40-55% market loss over the next 18 months or so? If not, take this opportunity to set things right. That’s not the worst-case scenario under present conditions; it’s actually the run-of-the-mill historical expectation.

Read Hussman’s Weekly Letter


  1. But what if you sell and the Fed hyperinflates by creating money at full speed? Then you are holding rapidly depreciating dollars.

    If you hold stocks and the Fed hyperinflates, won’t the numerical value go up, although the purchasing power might hold or go down.

    What will happen in the hyperinflation stage? Isn’t that the next stage after deflation?

  2. Hussman has to be wrong. I was listening to NPR (I know, fifty lashes) this afternoon and they had on one cheerful optimistic woman after another, diving deep into current market conditions, china, everything. It was all so clear to them. Your biggest mistake would be to let fear drive you out of the market. China is still growing. China is rebalancing. Don’t let your emotions cause you to do something crazy. Calm down. It’s all good (suckers)

  3. China “Punishes” Hundreds For “Maliciously” Manipulating The Market

    Submitted by Tyler Durden on 08/31/2015 07:40 -0400

    The deadly chemical blast in the Chinese port of Tianjin was a preventable catastrophe in which more than 100 people lost their lives thanks in part to what looks like the political connections of the warehouse’s owners and although an upfront, transparent investigation and honest assessment of the environmental impact is likely the only way to safeguard the public and ensure it doesn’t happen again, no one believes the Chinese government has the will to conduct such an investigation.

    But whatever you do, do not say any of the above if you live in China.

    Similarly, China’s stock market collapse was an entirely preventable financial catastrophe caused by the unchecked accumulation of margin debt and the encouragement of speculation, and the bursting of the equity bubble which began in June has been nothing short of a debacle that’s led to international condemnation and accusations that, even in a centrally planned world, Beijing’s particular brand of intervention is so egregious as to stray outside the bounds of manipulated market decorum.

    But if you live in China, don’t say that either.

    Over the last two months there were signs that Beijing would soon resort to outright, sweeping censorship as it relates to both the stock market and the Tianjin blast. For instance, in July, phrases like “rescue the market” were reportedly banned and in the wake of the Tianjin disaster, hundreds of social media accounts were shut down for spreading “blast rumors.”

    Now, ahead of a military parade that Xi Jinping will allegedly use to show the world that the Chinese lion “has woken up” (albeit with the amusing caveat that the lion is “peaceful, pleasant and civilized”), the Politburo apparently has seen just about enough criticism for its handling of the stock market collapse and the Tianjin blasts and as WSJ reports, more than 200 people have now been “punished” for their alleged role in “mislead[ing] society and the public, generat[ing] and spread[ing] fearful sentiment, and even us[ing] the opportunity to maliciously concoct rumors to attack [the] Party and national leaders.” Here’s more:

    The sweep targeted people who the government said spread false Internet rumors regarding events such as the stock-market turmoil and deadly explosions earlier this month in the port city of Tianjin, the Ministry of Public Security said Sunday.

    The government is facing intense public scrutiny in China over its management of the slowing economy and turbulent markets, as well as public anger over the blasts at a hazardous-chemical warehouse in Tianjin.

    In its statement, the public-security ministry didn’t identify most of the 197 alleged offenders, giving only surnames for some of them. The statement quoted four people, identified only by their surnames, as expressing regret for spreading false information. It didn’t elaborate further on individual offenses and punishment, except to note that 165 online websites and accounts were shut down.

    Statements described by the ministry as false included rumors that a man jumped to his death in Beijing because of the stock market slump, claims that at least 1,300 people were killed in the Tianjin blasts, and inflammatory rumors related to China’s commemorations of the 70th anniversary of victory in World War II.

    Sunday’s statement came just weeks after the Cyberspace Administration of China said it shut down 18 websites permanently and suspended another 32 websites for a month for allegedly publishing unverified information or letting users spread groundless gossip related to the Aug. 12 explosions in Tianjin, which killed at least 150 people and injured more than 700.

    China has also officially confirmed what multiple news outlets reported late last week. Namely that a journalist at Caixin and a prominent investment banker had been detained in connection with spreading “rumors” and “illegal trading.”From WSJ again:

    In the case of Mr. Wang, the Caijing reporter, Xinhua said an alleged fabrication was a July 20 report saying the China Securities Regulatory Commission was studying a withdrawal of government funds used to stabilize the domestic stock market amid a broad-based slump.

    Mr. Wang told investigators he wrote the report by combining market-related information with his own “subjective assessment.” More specifically, Wang says he “obtained the information [about the possible scaling back of CSF’s plunge protection buying] through the abnormal channel of gleaning, in private, information about the market.”

    So essentially, Wang’s criminal behavior amounted to reading publicly available information in “private” (which we presume means “at his desk”), drawing conclusions, and writing a story, which is of course contrary to the tried and true method of journalism in China wherein Beijing sends journalists a dispatch telling them what to say and then journalists just regurgitate it.

    As for Xu Gang, the CITIC executive, he has now apparently given a detailed account of his misdeeds, as has CSRC official Liu Wei who apparently “told investigators that he took bribes from an executive of a listed company to help that firm pass regulatory scrutiny, engaged in insider trading and made use of forged documentation to help a lover purchase an apartment in Shanghai.”

    Meanwhile, China has also brought in Li Yifei, chairwoman of Man Group’s China arm. From Bloomberg:

    Chinese authorities took Li Yifei, chairwoman of Man Group Plc’s China unit, into custody to assist with a police probe into market volatility, according to a person familiar with the matter.

    Li assisting with the investigation doesn’t mean she is facing charges or has done anything wrong. She has led Man Group in China since November 2011, according to her profile on LinkedIn. The person asked not to be identified because the probe isn’t public.

    We suspect maybe this was the mistake:

    In an interview with Bloomberg Television’s Stephen Engle in November, Li said investors and regulators in China were beginning to understand hedge funds.

    “The Chinese investors and regulators are beginning to understand that actually hedge fund is about hedging.”

    Yes, “actually hedge fund is about hedging,” which, as Citadel learned earlier this month, would “actually” be fine as long as by “hedging” Li means “buying” or any other activity which leads equities higher. Always higher. Never, ever lower.

    In any event, the Politburo has now abandoned all prestense of capital market liberalization and/or providing for an environment that’s conducive to any semblance of freedom of speech. This is of course predictable. It’s rather easy to claim that reforms are being implemented at a rapid clip both in terms of financial markets and in terms of society when everything is going well. But free markets can be painful when the invisible hand purges misallocated capital and freedom of the press can be equally painful when journalists unconstrained by censorship purge bullshit.

    Of course journalists face plenty of censorship even in the US, which is supposed to be the bastion of press freedom (just ask Pedro da Costa) and capital markets are everywhere and always manipulated by central planners.

    And that is perhaps the lesson Xi Jinping has yet to learn. That is, we all exist in a censorsed and manipulated world; the Politburo just hasn’t figured out how to be subtle about it yet.

  4. China Dramatically Intervenes To Boost Stocks Despite Reports It Won’t; US Futtures Slump On J-Hole

    Submitted by Tyler Durden on 08/31/2015 06:49 -0400

    Yesterday, the FT triumphantly proclaimed: “Beijing abandons large-scale share purchases”, and that instead of manipulating stocks directly as China did last week on Thursday and Friday, China would instead focus on punishing sellers, shorters, and various other entities. We snickered, especially after the Shanghai Composite opened down 2% and dropped as low as 4% overnight:

    zerohedge @zerohedge

    We’ll find out shortly just how much “China won’t intervene any more in the market”
    10:17 PM – 30 Aug 2015

    Less than five hours after this tweet, we found out that our cynical skepticism was again spot on: the moment the afternoon trading session opened, the “National Team’s” favorite plunge protection trade, the SSE 50 index of biggest companies, went super-bid and ramped from a low of 2071 to close 140 points higher, ending trading with a last minute government-facilitated surge, and pushing the Composite just 0.8% lower after trading down as much as -4.0%.

    It wasn’t just direct stock market intervention: Bloomberg reported that additionally the PBOC also conducted another Short-term Liquidity Operations with some banks Monday, adding that tenors offered included six-day loans. Recently, the PBOC had conducted 7-day CNY60b SLO at 2.35% on Aug 28 and 140b yuan 6-day SLO at 2.30% on Aug 26.

    China’s interventions were to be expected: what the FT got right is that the government is intent on “providing a “positive market environment in preparation for a big military parade this week to celebrate the 70th anniversary of the “victory of the Chinese people’s war of resistance against Japanese aggression.” The question is whether once the September 3 event is over, will China finally allow stocks to truly trade down. We doubt it: just like the Fed has found 7 years later when even the tiniest of rate hikes threatens to collapse the house of cards, so China will hardly dare to step away at least until the Chinese premier Li Keqiang is sacrificed, literally or metaphorically, to appease the millions who have lost everything and then some (thanks to margin).

  5. “What will happen in the hyperinflation stage? Isn’t that the next stage after deflation?”

    This is an excellent question, but the way I address it is that navigating a turn from 100 years of continuous compounded inflation to the greatest deflationary credit collapse in history remains far more important at this moment.

    We simply have no charts for these waters.

    The credit bubble of today is so much larger than that which preceded the Great Depression that it borders on being an entirely new entity, as yet nameless. The bursting of the bubble promises to collapse entire industries that are now dominant employers across the developed world’s economies.

    This is simply unprecedented. Discussing “what happens when (fill in the blank)” is meaningless when the (fill in the blank) will be but one variable among dozens (or hundreds) that have inverted.

    The only relevant information we have is:
    1. Being in debt during a deflationary period is a massive handicap.
    2. Servicing debt becomes difficult when every other person is losing his or her job.
    3. Industries that were the biggest beneficiaries of the old condition will be likeliest to be Ground Zero.
    4. Wealth in dollar terms will decline.
    5. Maintaining full dollar-for-dollar claim on wealth should be exceedingly difficult.
    6. “Winning” will be defined by losing less than most others, a complete inversion of the last 50 years.

    I would add a few conjectures:
    7. Only once the collapse is complete will Political Authority become fully involved in “reversing” it.
    8. What Political Authority does in the wake of the catastrophe will add to the hardships, and will have long-lasting negative effects (look at the insane centralization of the USA during FDR’s terms.)

    We don’t know the future. We can’t be SURE that the economy will move to a full reconciliation of excess debt this time—-I thought it would in 2000, I was sure it would in 2007, yet HERE WE ARE!

    I ——- BELIEVE —— this time is different. All the necessary ingredients for the greatest asset value collapse in history are now present, but that does NOT produce a Sure Thing.

    Look, folks. We’ve lived our lives (in the USA) in a theocracy by every honest measure. Belief in the palpably unreal (Progressivism, plus equalitarianism) has ruled the masses and rulers alike.

    We’ve survived it, even thrived under it despite the too-numerous-to-list evils this system produced.

    We’ll survive what it throws at us going forward, too. I hope.

  6. The mechanics/logistics of just how this thing breaks is the foremost question on my mind…we are in completely uncharted territory and there are so many ways we can go. During the last fourth turning people in general were more self-sufficient. had more “common” sense, less dependence on centralized utilities and their most sophisticated piece of “electronics” were vacuum tube radios. “Digital” currency, real-time data transfer, computers themselves, just-in-time logistics etc, NONE of this was ever even considered by the general public.

  7. By Robert Shiller

    In a soon-to-appear book, “Phishing for Phools: The Economics of Manipulation and Deception” (Princeton University Press), that I wrote with George Akerlof of Georgetown University, we argue that the proliferation of such stories is a natural part of economic equilibrium. Successful people who value their careers rely on an instinctive sense for what pitch will sell. Who knows what the truth is, anyway?

    As time goes on, the stories justifying investor optimism become increasingly shopworn and criticized, and people find themselves doubting them more and more. Even though people are asking themselves if prices are too high, they are slow to take action to sell. When prices make a sudden drop, as they did in recent days, people tend to become fearful, even if there is a subsequent rebound. With the drop they suddenly realize that their views might be shared by other people, and start looking for information that might confirm their belief. Some are driven to sell immediately. Others are slower, but they are all similarly motivated. The result is an irregular but large stock market decline over a year or more.

    Recently, people have started to wonder if the market is too high. Since 1989, I’ve conducted surveys of both individual and institutional investors. I ask respondents whether the stock market is overpriced, underpriced or about right. Our valuation confidence index is the percent of those investors who think the stock market is not overpriced — that is, who think it is fairly valued or undervalued. Though this index charts only six-month averages, it is noteworthy that it has been dropping over the last few years, to the lowest level since just before the stock market crash of 2000. Though it is not quite as low as at that time, it is lower than at the market peak in 2007.

    It is entirely plausible that the shaking of investor complacency in recent days will, despite intermittent rebounds, take the market down significantly and within a year or two restore CAPE ratios to historical averages. This would put the S.&P. closer to 1,300 from around 1,900 on Wednesday, and the Dow at 11,000 from around 16,000. They could also fall further; the historical average is not a floor.

  8. DC says: Being in debt during a deflationary period is a massive handicap.

    I agree, but it is good to be in debt during a hyper-inflationary collapse. Which way does it break? It mostly depends on one’s ability to determine which way a massive herd of several hundred million land mammals will turn? It is anyone’s guess. Of course, government’s responses will be heavy-handed and wholly comprised of short-term “solutions.”

    I guess I see more of a “systemic” crisis on the horizon. If there are thousands of mortgage defaults, like the last crash, they system kicks out the poor sub-prime saps and the already wealth scoop up some cheap properties. If there are several MILLION mortgage defaults, the whole system breaks–we can’t run a society where half the jobs are in repo. Same with the sub-prime autos–no on will go repossess autos if no one can afford gas. Cars wouldn’t hold any value in such a scenario. Or there’s the even bigger catastrophe of losing the power grid…no one is gonna care about credit card debt and no one would be able to gather/process all the debt data if they did.

    There are so many ways this can go and none of them are exactly pleasant. And the question of will we survive depends greatly on how you define “we.” I think, hopefully, most individuals will survive, I can virtually guarantee the human race will survive–even in the event of all out nuclear war, but will our current American “have it your way” “gender neutral” “MOAR screaming” culture survive? No way in hell, it is madness and unsustainable in myriad ways. I would say the exact same thing for our corporate and government structures as well….they have no chance of surviving long term simply because they consume so much more than they create.

    Good riddance to these…I just hope our current psychotic rulers don’t destroy the whole fucking planet out of pure spite when it becomes clear that they are playing a losing hand.

    1. US Equities Are Crashing Again – Dow Futures Down 430, AAPL -2.75%

      Submitted by Tyler Durden on 09/01/2015 08:48 -0400

      US equity futures markets have just pushed to fresh overnight lows, with the last leg down seemingly triggered by the CAD recession print. Let’s hope Cramer and Cook have another email up their sleeves as weakness in AAPL is notable – down 2.75% in the pre-market. Lastly, we noted US equities are rapidly catching back down to the XIV-implied lows as the last few days bounce evaporates.


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