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- John Hussman says stocks are due for substantial losses amid high valuations.
- Hussman has been warning of a big drop in recent years.
- The S&P 500 is up 16% year-to-date following a 20% loss in 2022.
John Hussman is fairly certain of one thing: investors who buy into the S&P 500 right now are doomed for a decade-plus of abysmal returns.
It’s something Hussman, the president of Hussman Investment Trust who called the 2000 and 2008 crashes, often refers to as a “long and interesting trip to nowhere.” With valuations historically high, it’s likely that 12 years from now investors end up pretty close to where they bought the index today (dividends notwithstanding).
Here’s Hussman’s favorite measure of valuation: total market cap of non-financial-sector stocks-to-total revenues of those stocks. While the ratio is down a bit from its peak in the last couple of years, it remains above the levels seen during the height of the dot-com bubble.
Hussman Funds
That’s Hussman’s favorite measure because of how accurate it is in predicting subsequent 12-year returns. The correlation is laid out in a scatter plot below. Current levels show we’re in for -4% annualized returns over the next 12 years.
Hussman Funds
Another valuation measure Hussman likes is the Shiller cyclically-adjusted price-to-earnings (CAPE) ratio. This measure averages the previous 10 years of valuations in order to smooth out the data set. Right now it shows that valuations are near those seen during the 1929 bubble.
Hussman Funds
Hussman believes that, just like in 1929 and 2000, stocks will probably see a steep sell-off by the time this cycle is completed.
In other words, much of those -4% annualized returns will be the result of one substantial drop in prices.
A big part of why Hussman believes that’s the case is poor investor sentiment — illustrated in this case by how many stocks are participating in the rally, which Hussman measures through a proprietary gauge of what he calls “market internals.” Historically, poor internals have meant declining stock prices.
Here’s the gauge in the chart below. When the red line is flat, stocks (blue line) typically underperform.
Hussman Funds
“Current market conditions create what we continue to view as a ‘trap door’ situation for the equity market. While the S&P 500 remains below its early 2022 peak, my impression is that far deeper market losses will emerge over the completion of this cycle,” Hussman wrote in a September 5 market commentary. “Investors often forget that the bulk of the 2000-2002 and 2007-2009 collapses occurred after the Fed ‘pivot,’ and the Fed eased the whole way down.”
Another reason Hussman’s outlook is so dire is that stock valuations remain high relative to where risk-free Treasury yields are.
To get back to valuation levels where investors could expect either 10% annualized returns on stocks, or 2% returns above what they could get in a 10-year Treasury (which currently yields above 4.2%), the S&P 500 would have to fall about 65%.
Hussman Funds
Hussman’s track record — and his views in context
Stock valuations are high by many measures, not just ones Hussman prefers.
The S&P 500’s 12-month forward price-to-earnings ratio is also above its all-time median. And the so-called Warren Buffett indicator, or market cap-to-GDP, is higher than during the dot-com bubble.
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Regression analyses show starting valuations do indeed play a role in how stocks perform over the long-term. This Bank of America chart shows that 80% of returns over a decade can be explained by where valuations started.
Bank of America
But Hussman’s call for a substantial sell-off is out of the norm. As the labor market remains strong, consumers continue to spend, and inflation drops, economists and strategists increasingly see a soft-landing scenario where the US avoids a recession and stocks retain much of their value.
It’s too early to tell, however, how the US economy will ultimately fare against a hawkish Federal Reserve. The longer the central bank leaves rates elevated, the more pressure they will put on consumers and businesses. Experts also say previous rate hikes are still working their way through the economy.
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 continued to grind mostly higher, he has 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:
- 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.
- He predicted in 2000 that the S&P 500 would likely see negative total returns over the following decade, which it did.
- 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 48% since December 2010, and has fallen about 4% in the last 12 months. The S&P 500, by comparison, is up about 12% 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.
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