“The information contained in earnings, balance sheets and economic releases is only a fraction of what is known by others. The action of prices and trading volume reveals other important information that traders are willing to back with real money. This is why trend uniformity is so crucial to our Market Climate approach. Historically, when trend uniformity has been positive, stocks have generally ignored overvaluation, no matter how extreme. When the market loses that uniformity, valuations often matter suddenly and with a vengeance. This is a lesson best learned before a crash rather than after one. Valuations, trend uniformity, and yield pressures are now uniformly unfavorable, and the market faces extreme risk in this environment.”
Hussman Investment Research and Insight, October 3, 2000
“One of the best indications of the speculative willingness of investors is the ‘uniformity’ of positive market action across a broad range of internals. Probably the most important aspect of last week's decline was the decisive negative shift in these measures. Since early October of last year, I have at least generally been able to say in these weekly comments that ‘market action is favorable on the basis of price trends and other market internals.’ Now, it also happens that once the market reaches overvalued, overbought and overbullish conditions, stocks have historically lagged Treasury bills, on average, even when those internals have been positive (a fact which kept us hedged). Still, the favorable market internals did tell us that investors were still willing to speculate, however abruptly that willingness might end. Evidently, it just ended, and the reversal is broad-based.”
Market Internals Go Negative, Hussman Weekly Market Comment, July 30, 2007
“The worst market return/risk profiles we estimate are associated with an early deterioration in market internals following severely overvalued, overbought, overbullish conditions. This is what we observe at present. In contrast, the strongest market return/risk profiles we estimate are associated with a material retreat in valuations coupled with early improvement in market internals. I have every expectation that we will observe this combination over the completion of the present market cycle. So I expect that, perhaps to the surprise of many who don’t understand this approach, we will be quite bullish and aggressively invested as market conditions shift over the completion of the present market cycle. But now is emphatically not that time.”
A Hint of Advance Warning, Hussman Weekly Market Comment, August 4, 2014
The most hostile subset of market conditions we identify couples overvalued, overbought, overbullish extremes with a breakdown in market action: deterioration of breadth, leadership and other market internals, along with a shift toward greater dispersion and weakening price cointegration across individual stocks, sectors and security types (what we sometimes call “trend uniformity”). The outcomes are particularly negative, on average, when that shift is joined by a widening of credit spreads. That’s a shift we observed in October 2000. It’s a shift we observed in July 2007. It’s a shift that we observe today.
Remember that severe market losses are not by their nature broadly announced by obvious catalysts. As I noted approaching the 2007 peak: “Once certain extremes are clear in the data, the main cause of a market plunge is usually the inevitability of a market plunge. That's the reason we sometimes have to maintain defensive positions in the face of seemingly good short-term market behavior.” Asking what particular news event will trigger a market loss “is like having an open can of gasoline next to your fireplace and blaming the particular spark that sets it off. We need not investigate the personality, life history or future career path of that particular spark.”
Present market conditions comprise an environment where risk-premiums are thin and are being pressed higher. See Low and Expanding Risk Premiums are the Root of Abrupt Market Losses for more on why this matters. The current shift does not ensure that the market will decline over the short-term, nor that it will crash in this instance. It’s also worth noting that we don’t rely on a crash, and that we can certainly allow for the possibility that valuations and market internals will improve in a way that reduces or relieves our concerns without severe market losses.
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