Guest Post
John Hussman’s presents a message no one wants to hear because nearly everyone is too busy believing for the third time in 17 years that “It’s different this time”.
Last week Hussman wrote about Valuations, Sufficient Statistics, and Breathtaking Risks. This week it’s more of the same with his post Behind the Potemkin Village.
The markets are so overvalued now that Hussman expects a 60% decline from here.
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There’s an apocryphal story that in 1787, during the journey of Empress Catherine II to Crimea, Prince Grigory Potemkin, the governor of the region, erected fabricated villages along the Dnieper River, which would be disassembled after she passed by, and rebuilt again downstream overnight.
When one examines the collapses of the tech bubble and the housing bubble, it’s evident that one of the central elements of those collapses was the gradual recognition by investors that the overvalued pieces of paper they were holding were actually little Potemkin Villages; temporarily glorious and impressive on the surface, but backed by much less than investors had imagined was there. What sort of “catalyst” is needed for a Potemkin Village or a Ponzi scheme to disappoint? Only the gradual or sudden discovery of the reality behind it: the recognition that there is no “there” there.
Market returns don’t just emerge from nowhere. They are driven by the sum of three factors: growth in fundamentals, income from cash distributions, and changes in valuations (the ratio of prices to fundamentals). For example, the 10% annual total return of the S&P 500 since 1960 also derives from growth in S&P 500 revenues averaging 5.7% annually since the 2000 peak, dividend income averaging about 3.0% annually, and a much steeper increase in the S&P 500 price/revenue ratio contributing 1.3% annually (taking the current price/revenue multiple to the same level observed at the 2000 market peak).
Consider these drivers today. Combining depressed growth prospects with an S&P 500 dividend yield of just 2.0%, the likelihood is that over the coming 10-12 years, even a run-of-the-mill reversion of valuations will wipe out the entire contribution of growth and dividend income, resulting in zero or negative total returns in the S&P 500 Index on that horizon, with an estimated interim market loss on the order of -60%.
Here are the facts: over the past several decades, due to a combination of demographic factors and persistently slowing productivity growth, the core drivers of real U.S. GDP growth have declined toward just 1% annually, with a likely decline below that level in the coming 10-12 years. Indeed, in the absence of any recession, U.S. nonfarm productivity growth has averaged just 0.8% annually since 2010 and 0.6% over the past 5 years, while the U.S. Bureau of Labor Statistics estimates labor force growth of just 0.3% annually in the coming years (which would be matched by similar growth in employment only if the unemployment rate does not rise from the current level of 4.3%). Add 0.6% to 0.3%, and the baseline expectation for real GDP growth is just 0.9%. Nominal growth is likely to be similarly weak.
While S&P 500 earnings growth has slightly outpaced revenue growth over the past two decades because of rising profit margins, recent record profit margins have now stagnated and have begun to retreat, resulting in the likelihood that earnings growth will match (at best) or even lag, overall economic growth in the years ahead. At the same time, the valuation measures we find most reliably correlated with actual subsequent S&P 500 total returns now average between 150-170% above historical norms that they have approached or breached by the completion of every market cycle in history. For a review of the historical reliability of these measures and popular alternatives, see the table in Exhaustion Gaps and the Fear of Missing Out
Let’s be clear. It has taken the third financial bubble in 17 years to bring the total return of the S&P 500 since the 2000 peak to just 4.8% annually, all of which we expect to be wiped out over the completion of the current market cycle. Even if investors are lucky, and valuations reach yet another bubble extreme 10-12 years from today, the annual total return of the S&P 500 between now and then is likely to be even lower than the 4.8% return since 2000, because the underlying economic drivers have deteriorated further. In my view, it’s substantially more probable that investors 10-12 years from now will find the S&P 500 Index at a lower level than it is today, with the average portfolio struggling to get back to zero from deeply negative interim losses.
What If?
It’s very difficult to present a fresh look each week on the same topic. I salute Hussman for his ability to do just that.
Even if he is only half-right on the duration and strength of the decline, public union pension plans in states like Illinois will be broke.
State of Denial and Hubris
In his article, Hussman present a total of seven charts to make a compelling case.
Most people ignore Hussman because they don’t like his message. Certainly, it’s not the message Wall Street wants you to hear. Importantly, Wall Street can repeat its message way more than those in the Hussman camp.
Some know full well the stock market is in a bubble but they expect they will get out on time. A few might manage. In aggregate, it’s impossible.
“Don’t Worry There is No Bubble”
Many of my readers think the “Fed won’t allow another major stock market decline”. But if the Fed could prevent bubbles from popping why did we have two crashes already?
That’s the message Wall Street wants people to believe. It’s also the message people want to believe.
I don’t know when this bubble will burst, nor does anyone else. But the bigger the bubble the louder the pop.
Fucking crash already!
In case you missed it, the crash has begun. Over 75% of the S&P stocks are in a downtrend, banks and the Fed is only buying big name DOW and S&P stocks to keep the averages up. When the cliff comes they will all jump off together fucking the pension funds and little guys. Companies have run out of money buying their stocks to get big bonus opportunities, and smart people are selling out their own companies big time. Be smart the shit is hitting the financial fan, Get out and into T bills or silver coins ( no one will transact gold ), ASAP. CONSIDER YOURSELF WARNED!!!
Husseman again. Does he still have a job?
Ok, well I would take Hussman’s rational approach to the talking heads on CNBC and various “fund” managers. At least he has the balls to tell the truth.
High Yield bonds have been sideways to down for a while now. Guess what all of these companies have using to buy their own stock? If yields go up in those bonds, (you know, how expensive that money is to borrow) how do you suppose they will keep buying their stock? And they have already fired everyone. Oh, and capex improvements have not been done in years, you know because stock is more valuable…..Oh, and about that demand thing, 70% consumer economy. That same consumer that can’t come up with $400.00 cash in an emergency. Yea right.
You can criticize Hussman all you like, but he has the figures and stats to back his position. Belief in the bubble continues….until it doesn’t. I don’t plan on my retirement funds evaporating when the doesn’t inevitably comes.
Not yet. Goldman Sachs is spreading doom and gloom at the present time.
Hey big pick ,I just sold some Gold as of last Friday at a local coin shop.They told me they would buy all I had if I wanted to sell.Who is right????
US govt debt passes 20 trillion after jumping 317 billion in a single day!
https://www.cnsnews.com/news/article/terence-p-jeffrey/debt-tops-20-trillion-first-time-jumps-317645000000-1-day
But it’s okay cause we owe it to ourselves, right? Party on, Garth.
Hussman is brilliant but generous with only a 60% decline. Energy is the problem- thanks chris martensen for opening these eyes about the EROI! No energy/cheap oil= no growth. Death to the FED.
EROI is worthless.
Study past history on energy sources like whale blubber, peat and wood – sources will be exploited as long as necessary or until something better comes along.
Gasoline is still roughly the same price as milk – impossible to position this as anywhere close to a problem. More importantly, gasoline prices in Europe – which are multiples of US prices – don’t seem to have had a negative effect there.
Hussman’s Hsgfx fund has way under performed the s&p the last 5 years.
I have studied bubbles.
My opinion : The stock market is not in a bubble yet but it is coming. Bubbles end with blow off tops. My call is that we will see the S&P reach 4000 before the end of 2018. There will be scary corrections (10 -15%) on the way up which will be needed to clear sentiment and set the stage for the next leg up. Look at the Nasdaq chart from Jan 1999 – Apr 2000 or silver from Jan 2010 to May 2011 to see what a bubble really looks like. Once the stock market goes “vertical” and is up at least 50% in 4 – 6 months then I would be would be worried. A 60% decline is then possible.
Gold: Short term — going down for a month or two. Gold usually corrects after a rapid 2 month rise. Long term — there will be a gold bubble in about 3- 4 years from now.
Market cap for all of S&P500 is about $22 trillion, so where can 60% of that can evaporate to ?
Money doesn’t vanish, it just moves; for every dollar made in the markets a dollar is lost somewhere else.
Where did it go in 2001 and 2009?
It can vaporize. It’s what someone is willing to pay.
Or able to pay, probably both in conjunction with each other.
Spender – a dollar is not made, or lost, in the markets until a sale happens. Mostly, the shares will just sit there, at a different, lower, potential value. Trade volume per year in the US is around $42 trillion. Far less than that is converted into profit or loss.
Average DJIA PE today is 21.9.
Which I consider way overvalued.
But, then, I’m old school and think anything over 12 is approaching overvaluation.
Maybe things have changed and I’ve just not been able to change with them.
Maybe I’m just too old to keep up with they why’s and wherefore’s of it all now.
Why and wherefore have the same meaning.
“Why’s and wherefore’s” is a colloquial phrase, an idiom, in the English language.
http://www.dictionary.com/browse/whys-and-wherefores