Latest from Hussman - nearing crash alert?
The Market Climate remains characterized by extremely unfavorable valuations and unfavorable trend uniformity. There's a good chance that the Market
Climate will shift to a Crash Warning this week, but most of our models are based on weekly closing data, so we will not have confirmation of that until
Friday. A Crash Warning does not mean that the market must, or should strongly be expected to crash. Rather, it means that the Market Climate reflects 1)
overvaluation, 2) unfavorable trend uniformity, and 3) hostile yield trends, particularly interest rate trends. That combination has only occurred in about 4% of
market history, but every historical crash of note has emerged from this one set of conditions. Again, however, a Crash Warning is not a forecast of a crash,
but an identification of conditions that have given rise to past crashes. We don't forecast. We identify.
I continue to see the recent surge in long-term interest rates taken as evidence of an oncoming economic upturn. It simply isn't true. Interest rates rise for
essentially two reasons. One is inflation expectations. The other is increased risk premiums. The recent surge in bond yields is evidence only that risk
premiums have advanced back to normal levels.
The whole notion that interest rates rise due to output growth is simply false anyway. Statistically, faster economic growth is correlated with lower bond
yields, and this relationship is highly significant statistically. The strong positive relationship is between inflation and bond yields. As I've written frequently
over the years, higher output growth is actually disinflationary. Inflation and rising interest rates emerge when output growth can't keep pace with demand
growth - that is, when observed output growth slows in the face of strong demand. That's not what we have here, so we have to infer that risk premiums, not
inflation, are the cause of the bond yield surge here. That was predictable weeks ago, at least from these updates.
I realize that it seems counterintuitive that strong output growth should be disinflationary. Think of it this way. If inflation is too much money chasing too few
goods, what happens if there are more goods? You guessed right. Again, inflation (and interest rate pressure related to inflation) emerges when output growth
can't keep pace with demand growth. That is, when output isn't growing enough.
Don't conclude that slow output growth is always inflationary though. When output growth slows, but demand growth slows even faster, there is no pressure
on inflation. As usual, you have to think about equilibrium - it's not the rate of growth in GDP, but the relationship between supply growth and demand
growth that's crucial.
With the NAPM inflation index falling, and the ECRI future inflation gauge now at the lowest level on record, growth expectations and inflation pressures are
simply not behind the recent surge in bond yields.
So the proper inference is that risk premiums are rising. Look in the corporate debt sector and you'll see the same thing. Look at utility yields and you'll see
the same thing. Yet stocks currently reflect among the lowest risk premiums in history. As I've written frequently, every market crash is driven first and
foremost by a surge in the risk premium demanded on stocks by investors.
This is why we take the Crash Warning combination so seriously. A Crash Warning is a situation in which stocks are overvalued (so risk premiums are low),
trend uniformity is poor (so investors are not displaying a robust preference to take on market risk), and yield trends are hostile (so yields and risk premiums
are under significant upward pressure). When low yields on long-term securities are forced higher, watch out.
If P/E ratios and yields on stocks were to remain constant forever, stocks would be priced to deliver approximately 7.5% annual total returns; roughly 6%
from long-term earnings growth (the peak-to-peak norm for the past 10, 20, 50 and 100 years on the S&P), and 1.5% from dividend yield. Now suppose that
investors demand 8.5% long-term returns from stocks. They can't force the long-term growth rate of earnings up through wishful thinking, so they have to
force prices down until the dividend yield is 2.5% rather than 1.5%. That relatively modest increase in required returns - from 7.5% to 8.5% - would induce a
40% plunge in market prices.
Please, please, please don't imagine that this could not possibly happen. Such a decline would not even bring the P/E ratio on the S&P 500 to the historical
norm for bear market lows. Again, these are not forecasts, and we would be quick to reduce our hedges if trend uniformity was to improve. But here and now,
we have a defensive climate that may very well shift to a Crash Warning by the end of this week. About three-quarters of market history is spent in relatively
constructive climates. About 96% of market history is spent outside of Crash Warnings. There have always been, and will always be, very favorable climates in
which to take stock market risk, sometimes very aggressively. This is not one of them. |
