John Hussman on Secular Bear Markets

We typically do not include market views in this blog for the simple reason that tail-hedging does not require any forecasting.  But it is certainly feasible to measure relative levels of risk (see Taleb, Antifragile) and Hussman does a better job of it than most.  Here below are excerpts of this week's Hussman missive:


Present market and economic conditions highlight a fairly dramatic disparity between continued economic and valuation headwinds (particularly on a “cyclical” horizon of 18-24 months) and complacent short-term conditions that rest on the continuation of massive monetary and fiscal imbalances. It’s obvious even from a casual observation of economic conditions that these imbalances are inconsistent with a healthy economy; short term interest rates near zero, monetary base at 18% of nominal GDP (more than twice the level that would be consistent with short-term yields at even 2%), and a Federal deficit near 10% of GDP. Because it is an accounting identity that the deficit of one sector must be the surplus of another, and neither consumers nor our trading partners are running surpluses, it follows that our massive Federal deficit has temporarily driven corporate profit margins to historic highs about 70% above their norms even while wages as a percent of GDP have reached a record low.

Despite these imbalances, as long as Wall Street collectively closes its ears and hums, everything seems to be just fine. Sure, valuations are rich on the basis of normalized earnings, but stocks have performed well in hindsight. Sure, short-term interest rates are at zero, but investors have found what they believe is value in the higher interest rates available on junk debt. Sure, the labor force participation rate has plunged back to 1980 levels while every cohort of the population has lost jobs in the past 3 years except workers over the age of 55, but the payroll figures remain positive to-date. Sure, Europe is already in recession, with a largely insolvent banking sector, but for now, words have been enough to talk investors down from concern about any of that.

For our part, we continue to focus on the prospective market return/risk profile that has been associated with prevailing market conditions (including not only post-war and Depression-era data, but also data from the most recent cycle). The fact is that market conditions vary measurably over the course of the bull-bear market cycle. It's true that repeated “kick-the-can” interventions during the most recent cycle have created more variability in the lag between unfavorable conditions and subsequent market losses. Still, even this did not prevent significant corrections in 2010 and 2011. The corrections in 2012 have been fairly shallow despite fairly extreme conditions from the standpoint of our own return/risk estimates, but we also observed that in 2000 and 2007 – when it would have been tragic to confuse the postponement of bad outcomes with an escape from them. I have little doubt that the coming market cycle will provide extended opportunities for an unhedged and even aggressive exposure to market risk. At present, however, I am convinced that investors are mistakenly reaching for yield in credit-sensitive debt, misled by temporarily elevated profit margins in the stock market, overconfident about government safety nets, complacent about European risks, and still likely to be blindsided by a U.S. recession.

We continue to view the stock market as being in a “secular bear” – a period that includes a series of separate “cyclical” bull and bear markets, with the defining characteristic that successive bear market troughs move toward increasingly depressed levels of valuation. Secular bears begin from elevated valuations – generally Shiller P/E’s well above 18 (the ratio of the S&P 500 to the 10-year average of inflation-adjusted earnings), and typically end about 14-18 years later, at depressed valuations and after a number of separate market cycles. There are certainly many periods during a "secular" bear market when it makes perfect sense to take moderate and even aggressive "cyclical" risks, but it is worth noting that the average "cyclical" decline in a "secular" bear has wiped out about 80% of the prior bull market advance.

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I believe that normalized valuations present an accurate view of prospective market returns here. There is enormous risk, in my view, in the temptation to accept zero interest rates and low single-digit prospective market returns as an enduring characteristic of the financial markets while ignoring the unsustainable distortions that have produced this environment. In the short-run, there may be near-term returns available in reaching for yield by accepting greater credit risk, or speculating on periodic relief rallies even at present valuations. Those prospects, however, don’t change our view that stocks remain in a secular bear market.

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Fund Notes

As of last week, our estimates of prospective return/risk in stocks remained unusually negative. Strategic Growth remains fully hedged, with a staggered-strike hedge that raises the index put option side of our hedge closer to market levels, representing about 2% of assets in additional put option premium looking out to the first quarter. That said, we don’t expect to raise those strikes in the event of a further advance from here, as our real concern is about the potential for severe, indiscriminate market weakness (“tail risk”), and not simply a few percent of market losses.