A notorious market bear who called the dot-com bubble says investors can expect negative S&P 500 returns over the next 20 years with the recovery 'extensively' priced in — and warns that a cocktail of leverage and high valuations is setting up stocks for a 35% drop
- John Hussman is again sounding alarm bells, warning that stocks could drop 25-35% in the near-term.
- His concerns stem from high valuations and the amount of leverage in the market.
- He also said investors are likely staring down two decades of negative returns from the S&P 500.
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Stocks this month have seemed to hit a new record high just about every day as they continue their ascent from the depths of one of the most vicious crashes in market history.
Enjoy it while it lasts.
That’s the message from notorious market bear John Hussman, anyway.
Hussman, the president of the Hussman Investment Trust, warned in a Monday note that stocks have ‘extensively’ priced in the economic recovery ahead, and that dizzyingly high valuations are setting up the S&P 500 for two decades of negative average annual returns.
“When a good market valuation measure rises, the extra return you celebrate has simply been removed from the future,” Hussman wrote. “When a good market valuation measure collapses, the shortfall of return that you suffer has also been added to the future. It’s important to know where you stand in that cycle.”
To Hussman, we currently stand in an unfavorable spot, staring down weak returns as valuations remain extended and stocks outperform.
But Hussman also acknowledged the importance of a valuation indicator’s reliability. The one he likes most is price-to-revenue, shown below, because of its track record of projecting future total market returns after taking into account dividends. The ratio is at 3.07, higher than dot-com-bubble levels.
Given today’s outsized price-to-revenue valuation, Hussman seems to see a fair likelihood of two decades of negative returns — or in a best-case scenario, very weak returns — ahead for the S&P 500. This is despite the strong economic growth that most, including him, expect ahead.
He pointed to returns after the dot-com crash in 2000 as precedent.
“In the 9 years from the bubble peak in 2000 to the market trough in 2009, S&P 500 revenues grew at an annual rate of 4.8% annually,” he said. “Meanwhile, however, the price/revenue ratio of the index collapsed from 2.36 to just 0.68.”
Below is Hussman’s current outlook on the expected 12-year returns of multiple asset classes. The best opportunities he sees are in corporate bonds and utilities.
In the shorter-term, Hussman also expects a 25-35% crash in the S&P 500 — again despite bullishness on economic growth prospects — that will be “driven by nothing more than the sudden concerted effort of overextended investors to sell, and the need for a large price adjustment in order to induce scarce buyers to take the other side.”
He said high valuations and the amount of leverage in the market are fueling these concerns. But he also said he sees early deterioration in market factors like breadth, leadership, price-volume behavior, and participation.
Hussman’s track record — and his views in context
While Hussman’s view that the S&P 500 will pull back 25-35% is more extreme than the smaller dips others might expect the index to take going forward, Hussman has company in his views on extended valuations and weak future returns in the face of strong economic growth ahead.
Bank of America this week raised their S&P 500 earnings-per-share estimate for this year thanks to their economists’ rosier view on the recovery, but declined to raise their price target of 3,800 along with it because of where valuations are. The target implies a 9% drop from current levels and is on the low end compared to other major banks. They also expect a meager 2% annual return from the benchmark index over the next 10 years.
The bank also emphasized the importance of valuation for determining long-term returns. Over 10 years, valuation can account for 80% of why future returns will behave like they do.
Morgan Stanley also said on Monday that the economic recovery is mostly priced in, and that stocks are beginning to enter a mid-cycle phase earlier than expected.
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 has continued to grind mostly higher, he’s persisted with his doomsday calls.
But before you dismiss Hussman as a wonky perma-bear, consider his track record, which he broke down in a recent blog post. Here are the arguments he lays out:
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.
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.
However, Hussman’s recent returns have been less-than-stellar. His Strategic Growth Fund is down about 46% since December 2010, though it’s risen more than 12% in the past year.
Still, the amount of bearish evidence being unearthed by Hussman continues to mount. 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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