With US stocks having lost more than 20% year-to-date amid coronavirus worries, investors may be wondering if now is the time to buy certain shares at a discount. After all, haven’t we been taught to buy “when there’s blood in the streets,” and to “be greedy when others are fearful”?
John Hussman, the former economics professor who is now president of the Hussman Investment Trust, ardently disagrees with that school of thought — at least in today’s environment.
“What we’re seeing today in the financial markets is just an initial episode of significant risk aversion,” he penned in a recent client note. “Though market valuations are about 24% lower than they were at the 2000 and February 2020 highs, they’re actually about the same level we saw at the October 2007 market peak, and still about double the historical norm.”
Clearly, to Hussman, we’re still a long ways away from what he refers to as “run-of-the-mill, historical norms” in valuations. Just because stocks have fallen precipitously from their peak doesn’t make them a screaming buy.
According to Hussman’s calculations, with valuations at current levels, the 10-year estimated return for the S&P 500 is just 1.4%, mirroring the projected returns leading up to the peak in the financial crisis. Although this is an improvement from Hussman’s February projection of negative 10-12 year estimated returns, 1.4% is still nothing to write home about.
He provided the following chart reflecting projected and historical returns across different asset classes for context.
In addition to valuations, Hussman likes to lean on market internals and measures of overextension to provide an all-encompassing picture of where market sentiment is, and which direction it’s trending.
“If internals are unfavorable, it’s best to avoid a fully-unhedged position, much less a leveraged one,” he said.
Below is Hussman’s proprietary measure of market internals (red line) juxtaposed against the S&P 500’s cumulative total return (blue line). As of today, internals remain negative.
That brings Hussman to the third market component he keeps a keen eye on: overextension.
“I would consider it terribly imprudent to step into an unhedged position, in a still-overvalued market with unfavorable market internals, just because short-term market action is highly oversold,” he added. “There’s absolutely no assurance that an oversold market will not become decidedly more oversold.”
Put differently, investors that rely too heavily on short-term signals of overbought and oversold market conditions within the scope of a larger trend are putting themselves in danger.
Against that backdrop, Hussman delivers a final warning.
“The quick calculation is to consider the possibility that we actually see just 1.4% S&P 500 total returns over the coming 10-year period, from current valuation levels, with a potential (not “predicted” or inevitable) interim loss on the equity component of the portfolio on the order of about 50% from here, which would be gradually recovered,” he said.
Hussman concluded: “Consider what that would mean in dollars. If that outcome would be unfortunate, but tolerable, there may be no need to adjust your exposure to market risk. If it would not be tolerable, review your exposure.”
But before you dismiss Hussman as a wonky perma-bear, consider his track record, which he broke down in his latest blog post. Here are the arguments he lays out:
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
In the end, the more evidence Hussman unearths around the stock market’s unsustainable conditions, the more worried investors should get. Sure, there may still be returns to be realized in this market cycle, but at what point does the mounting risk of a 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.
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