Hussman as Short-Term Bearish as He Gets; What About the Long-Term Picture? Three Key Points

I cannot recall a time when fund manager John Hussman as short-term bearish as he is now.

The title of his recent article says it all: Hard-Negative

With the exception of extreme market conditions (see Warning- Examine All Risk Exposures , and Extreme Conditions and Typical Outcomes ), I try not to wave my arms around about near-term market risks, but I think it's important to cut straight to the chase here. The present market environment warrants unusual concern, in my view. Based on a wide variety of evidence and its typical market implications over an ensemble of dozens of subsets of historical data, the expected return/risk profile of the stock market has shifted to hard-negative. This places us in a tightly defensive position. This isn't really a forecast in the sense that shifts in the evidence even over a period of a few weeks could move us to adjust our investment stance, but here and now we observe conditions that have often produced abrupt crash-like plunges. This combination of evidence includes elevated valuations, overbullish sentiment, market internals best characterized as a "whipsaw trap" on the basis of typical follow-through, heightened credit strains, and clear evidence (on reliable forward-looking indicators) of oncoming recession, among other factors.

Long-Term Too Bullish?

It's important to note that Hussman is not making a prediction. Rather it's Hussman's assessment that the risk-reward setup at the present time merits extreme caution. I share that view.

It's the next few paragraphs where I wonder if Hussman is actually over-bullish.

On a valuation front, we estimate that the S&P 500 is likely to achieve an average total return over the coming decade of about 4.8% annually. This is certainly better than the projected returns that we have observed over much of the past decade, but then, the past decade has produced virtually no total return for equity investors at all.

click on chart for sharper image

We estimate that the S&P 500 would have to trade at about the 800 level in order to achieve 10-year prospective returns of 10% annually. Importantly, even a magical "fix" out of Europe would do nothing to change that algebra.

Is 60 Years Long Enough?

I am wondering if 60 years is long enough. We have had huge PE expansion-contraction cycles in both directions in the past 60 years but there has not been...

1. Consumer Deleveraging Cycle
2. Negative Demographic Shock

Might it be the case the US stock market follows something more like the Nikkei? Certainly, even if it is not that extreme.

Negative Returns for a Decade?

Let's revisit a table I posted in Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think, on February 7, 2011.

Annualized Rates of Return with Starting PE 21 or Greater
Year	PE	AR 1	AR 10	AR 20
1901	22.7	9	4	3
1902	22.0	-12	4	3
1928	21.3	33	-2	2
1929	27.6	-16	-4	0
1930	21.5	-30	-3	1
1964	22.6	7	1	4
1965	23.3	-3	0	5
1966	21.3	8	2	6
1967	21.6	7	1	7
1968	21.5	0	1	6
1995	22.7	21	7	?
1997	31.0	19	4	?
1998	36.0	18	1	?
1999	42.1	4	-1	?
2000	41.7	-17	?	?
2001	32.1	-16	?	?
2002	25.9	-2	?	?
2003	24.1	17	?	?
2004	26.4	7	?	?
2005	26.0	9	?	?
2006	26.0	13	?	?
2007	26.8	-16	?	?
2010	23.0	?	?	?

Variance over Time

• The first year rate-of-return ranges from -30 to +33.
• The annualized rate-of-return for the first decade ranges from -4 to +7.
• The median rate-of-return for the first decade is +1.

That median rate of return going forward will be influenced in an unknown but likely negative fashion from the current starting point and high PE valuations for the years that have yet to be determined.

Annualized Rates-of-Return Starting PE Less Than 13

The following table shows annualized rates-of-return for the current year, the 10th year, and the 20th year for each year in which the PE started at 13 or lower.

Annualized Rates of Return with Starting PE 13 or Less
Year	PE	AR 1	AR 10	AR 20
1913	11.9	-3	4	4
1914	11.1	7	5	5
1915	11.5	18	7	5
1916	12.0	-3	7	6
1917	8.8	-7	10	6
1918	6.4	20	14	7
1919	6.5	-5	15	5
1920	5.3	-11	13	5
1921	5.4	26	10	5
1922	7.5	6	1	3
1923	7.9	9	4	5
1924	8.4	26	4	5
1925	10.1	16	2	4
1926	11.7	24	5	4
1932	8.1	32	5	9
1933	11.1	13	5	8
1934	12.2	9	5	8
1942	9.2	34	13	11
1943	11.0	10	10	10
1944	11.3	21	11	10
1947	11.2	5	12	10
1948	10.7	2	12	10
1949	9.9	24	5	4
1950	11.2	24	15	10
1951	12.0	23	12	9
1953	12.0	21	10	9
1974	10.9	5	8	9
1975	10.2	19	9	10
1976	11.5	-2	10	10
1977	10.4	0	12	11
1978	9.4	9	11	12
1979	8.9	16	12	12
1980	8.8	10	10	12
1981	8.5	-5	11	10
1982	7.3	33	12	9
1983	9.6	1	10	8
1984	9.4	17	10	9
1985	10.7	25	10	8

Variance over Time

• The first year rate-of-return ranges from -11 to +34.
• The annualized rate-of-return for the first decade ranges from +4 to +15.
• The median rate-of-return for the first decade is +10.

Three Key Points

1. Starting valuation matters
2. Starting valuation is bad
3. The median rate-of-return for the first decade with these starting valuations is +1

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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