One of John Hussman‘s main problems with investing in the broader stock market is its valuation levels.
For those investing for the long term, high valuations tend to be terrible for returns over a subsequent decade or so.
Hussman, the president of the Hussman Investment Trust who called the 2000 and 2008 bubbles, considers his most preferred valuation metric the ratio of market-cap of non-financial stocks to their gross value added (essentially total revenue). At the moment, it’s hovering near levels seen only in 1929 and 2021. Here’s the latter measure below.
Hussman Funds
These levels indicate the S&P 500 is likely to return around -5% annualized over the next 12 years, according to Hussman’s math. Other classic valuation metrics, like the Shiller CAPE ratio, are also historically high.
But Hussman said in a recent note that he’s not only concerned about the long-term outlook for stocks. Other evidence, when paired with high valuation levels, leads him to believe stocks could be in danger of a near-term pullback.
Namely, there’s Hussman’s proprietary gauge of what he calls “market internals,” which he has used as a thermometer of investor sentiment since he created it in 1998. It looks at the performance of thousands of different securities to measure the uniformity or ubiquitousness of bullish sentiment.
The gauge is relatively flat, as shown in the chart below in red. Notice how during prior extended flat periods, the market has underperformed in a big way. The indicator seemed to perform well once again in 2022 when the market fell 25% peak-to-trough, but the S&P 500 has rallied a staggering 46% since that bottom.
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Hussman is also concerned with the market’s “overextended conditions,” or various technical indicators showing stocks are getting ahead of themselves.
For example, here is a chart from a February note showing the S&P 500 rising well above its 40-day moving averages despite other poor market conditions.
“The red bars show points where the S&P 500 was more than 6% above its 40-day smoothing, yet with fewer than 62% of individual stocks above their own respective 200-day averages, unfavorable internals on our primary gauge, lopsided bullish sentiment, and (as a paean to zero-interest rate speculation), interest rates above 1%,” Hussman said.
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The combination of these three elements creates a near-term risk cocktail for investors, he said.
“Presently, we observe neither favorable valuations, nor favorable market internals, while our syndromes of overextension remain consistent with the risk of an abrupt air-pocket, panic, or crash. Even with the adaptations we’ve made in this cycle, present observable conditions encourage a strongly defensive stance here,” Hussman said. “Nothing in our discipline relies on a forecast, a collapse, or even a retreat to historically normal valuations, but we do take prevailing conditions seriously.”
By the time the current market cycle bottoms out, the S&P 500 could well have fallen by 50%-70%, Hussman said.
Hussman’s views in context
While Hussman’s warning is extreme, other respected names have cautioned investors about a similar potential outcome.
One of them is Jeremy Grantham, the cofounder of GMO, who also called the 2000 and 2008 crashes. Since early 2022, Grantham has warned that stocks are in a “superbubble” that would eventually pop in spectacular fashion.
“There has never been a sustained bull market starting from a Shiller price-to-earnings ratio of 33 — it’s in the top 2% of the historical range,” Grantham said at the Exchange conference in Miami in February. “There’s never been a sustained rally starting from full employment. If you want to have a long, impressive rally, you want to see profit margins down, unemployment up, and PEs low.”
David Rosenberg, who called the 2008 recession while working as Merrill Lynch’s chief economist, and Gary Shilling, who was also Merrill Lynch’s chief economist at one point, have also warned in recent months of significant declines awaiting stocks.
But most strategists on Wall Street have more constructive outlooks and generally see any downside after the recent rally as being less severe.
The US economy has given investors reason to cheer, with inflation still under 4% while job gains have been steady. The Federal Reserve also looks poised to lower interest rates multiple times this year after its record-pace onslaught of hikes from 2022-2023. If positive economic data continues to come in, investors may have little reason to sell in the months ahead.
Hussman’s track record
For the uninitiated, Hussman has repeatedly made headlines by predicting a stock-market decline exceeding 60% and forecasting a full decade of negative equity returns. And as the stock market ground mostly higher, he persisted with his doomsday calls.
But before you dismiss Hussman as a wonky perma-bear, consider again his track record. Here are the arguments he’s laid out:
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He 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.
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He predicted in 2000 that the S&P 500 would likely see negative total returns over the following decade, which it did.
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He predicted in April 2007 that the S&P 500 could lose 40%, then it lost 55% in the subsequent collapse from 2007 to 2009.
However, Hussman’s recent returns have been less than stellar. His Strategic Growth Fund is down about 51% since December 2010, and has fallen 14.7% in the last 12 months. The S&P 500, by comparison, is up about 33% over the past year.
The amount of bearish evidence being unearthed by Hussman continues to mount, and his calls over the last couple of years for a substantial sell-off began to prove accurate in 2022. Yes, there may still be returns to be realized in this new bull market, but at what point does the mounting risk of a larger crash become too unbearable?
That’s a question investors will have to answer themselves — and one that Hussman will keep exploring in the interim.
