Last week, the S&P 500 came within 1% of reprising a syndrome that we’ve characterized as a Who’s Who of Awful Times to Invest, featuring a Shiller P/E over 18 (S&P 500 divided by the 10-year average of inflation-adjusted earnings), the S&P 500 more than 50% above its 4-year low and 8% above its 52-week smoothing, investment advisory bulls (Investors Intelligence) over 47% with bears below 27%, and Treasury bond yields higher than 6 months earlier. This combination is one of numerous and nearly equivalent ways of defining an “overvalued, overbought, overbullish, rising-yields” syndrome. While there are certainly numerous conditions that are informative about stock market returns, and capture a much broader set of negative market outcomes, I don’t know of any other syndrome of market conditions – however defined – that has been so consistently hostile for stocks over the past century.
The historical instances corresponding to the above conditions represent a chronicle of overextended bull market rallies, where investors would typically have been quite incorrect to declare victory at halftime:
December 1972 - January 1973 (followed by a 48% collapse over the next 21 months)
August - September 1987 (followed by a 34% plunge over the following 3 months)
July 1998 (followed abruptly by an 18% loss over the following 3 months, and at the beginning of a nearly 14-year period where the S&P 500, including dividends, has underperformed Treasury bills, with the S&P 500 nearly 30% lower four years later)
July 1999 (followed by a 12% market loss over the next 3 months, and a series of whipsaw recoveries and losses, with the S&P 500 over 40% lower three years later)
January 2000 (followed by a spike 10% loss over the next 6 weeks, a series of whipsaw recoveries and losses, and finally a bear market that took the S&P 500 over 45% below its Jan 2000 level by late 2002)
March 2000 (followed by a spike loss of 12% over 3 weeks, and a 49% loss into 2002)
July 2007 (followed by a 57% market plunge over the following 21 months)
January 2010 (followed by a 7% "air pocket" loss over the next 4 weeks, with a recovery into April and then a renewed decline, leaving the S&P 500 about 11% lower by July)
April 2010 (followed by a 17% market loss over the following 3 months)
December 2010 (near the start of QE2, and followed by a 10% further advance in the S&P 500 into May 2011, when an additional syndrome emerged that was also observed last week – see Extreme Conditions and Typical Outcomes – whereupon an 18% market plunge wiped out the entire gain, and then some).
March 2012 (followed by a further advance of about 3% over the following 3 weeks, and then a quick if unmemorable market decline of nearly 10%).
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At present, current profit margins are consistent with earnings contraction over the coming 4-year period at something close to a -10% annual rate, implying a drop in corporate profits by more than one-third in the coming years (even assuming intervening growth in GDP). That sort of decline would be consistent with a normalization of profit margins, without taking them below their historical average. Investors who believe that stocks are “fairly priced” on the basis of “forward operating earnings” seem to have no appreciation of the extent to which depressed savings rates and massive government deficits have temporarily boosted corporate profits over the past few years (see Too Little to Lock In for the accounting relationships here).
The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Only comments in the Fund Notes section relate specifically to the Hussman Funds and the investment positions of the Funds.
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The historical instances corresponding to the above conditions represent a chronicle of overextended bull market rallies, where investors would typically have been quite incorrect to declare victory at halftime:
December 1972 - January 1973 (followed by a 48% collapse over the next 21 months)
August - September 1987 (followed by a 34% plunge over the following 3 months)
July 1998 (followed abruptly by an 18% loss over the following 3 months, and at the beginning of a nearly 14-year period where the S&P 500, including dividends, has underperformed Treasury bills, with the S&P 500 nearly 30% lower four years later)
July 1999 (followed by a 12% market loss over the next 3 months, and a series of whipsaw recoveries and losses, with the S&P 500 over 40% lower three years later)
January 2000 (followed by a spike 10% loss over the next 6 weeks, a series of whipsaw recoveries and losses, and finally a bear market that took the S&P 500 over 45% below its Jan 2000 level by late 2002)
March 2000 (followed by a spike loss of 12% over 3 weeks, and a 49% loss into 2002)
July 2007 (followed by a 57% market plunge over the following 21 months)
January 2010 (followed by a 7% "air pocket" loss over the next 4 weeks, with a recovery into April and then a renewed decline, leaving the S&P 500 about 11% lower by July)
April 2010 (followed by a 17% market loss over the following 3 months)
December 2010 (near the start of QE2, and followed by a 10% further advance in the S&P 500 into May 2011, when an additional syndrome emerged that was also observed last week – see Extreme Conditions and Typical Outcomes – whereupon an 18% market plunge wiped out the entire gain, and then some).
March 2012 (followed by a further advance of about 3% over the following 3 weeks, and then a quick if unmemorable market decline of nearly 10%).
...
At present, current profit margins are consistent with earnings contraction over the coming 4-year period at something close to a -10% annual rate, implying a drop in corporate profits by more than one-third in the coming years (even assuming intervening growth in GDP). That sort of decline would be consistent with a normalization of profit margins, without taking them below their historical average. Investors who believe that stocks are “fairly priced” on the basis of “forward operating earnings” seem to have no appreciation of the extent to which depressed savings rates and massive government deficits have temporarily boosted corporate profits over the past few years (see Too Little to Lock In for the accounting relationships here).
The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Only comments in the Fund Notes section relate specifically to the Hussman Funds and the investment positions of the Funds.
Read the complete commentary
