Renowned market bear, John Hussman, who had correctly predicted the market crashes of 2000 and 2008, has warned that stocks are at risk of profound losses as valuations remain at historic extremes. In a note, Hussman dismissed the current rally as a narrow and selective speculative blowoff, driven by fears of missing out the resumption of a bubble that is in the early stage of a collapse. Hussman’s view is that the equity market is likely to suffer profound losses over the completion of a full market cycle.
Both valuations and market sentiment are currently unfavorable according to Hussman, who says that stock market price action is a product of these two factors. Valuation measures such as Shiller cyclically adjusted price-to-earnings (CAPE) ratio is still historically elevated and trading at levels seen in 1929. Hussman says this measure alone will lead to weak returns for investors over the long-term. Furthermore, recently, there have been warnings of a narrow participation in the S&P 500’s rally.
Hussman warned of peak-to-trough declines of 60%, which is a long way down since the current market momentum is only down 8% from its January 2022 peak. This is based on the math that the stock market would have to fall to return to valuation levels where one could historically expect 10% annual returns.
He has also warned that losses would be significant using the equity risk premium. For the S&P 500 to return to even a 0% premium over Treasury yields, the index would have to fall by more than 34% from current levels.
Warning signs of a recession, such as a deeply inverted Treasury yield curve and slowing manufacturing activity, are present. However, the labor market remains strong, with unemployment at 3.7% and monthly job gains robust. While jobless claims are starting to inch up, there is no reason for alarm yet.
With mounting bearish evidence, the question for investors is when does the mounting risk of a larger crash become too unbearable?
Hussman’s call for bearish markets has been hearsay over the years. Despite his recent returns being less than sublime, his forecast proved accurate in 2022. The heightened risk of a larger crash is a question that investors have to answer themselves, and one that Hussman will keep exploring.
