If you thought the stock market correction in October was bad, you ain’t seen nothing yet.
He actually argues the market has been headed for an imminent reckoning since early February, another period that featured a sharp stock drawdown. It was at that point that Hussman says so-called market internals started to deteriorate, leaving equities particularly vulnerable.
Hussman has become a big fan of the predictive power of market internals, which he says provide valuable signals on investor sentiment. They’ve taken on new significance to him since, as he describes it, valuations have been rendered largely useless — at least in the short term.
“Speculative psychology has always allowed valuations to run well beyond historical norms over portions of the market cycle,” Hussman wrote in a recent blog post. “Valuations only ‘work’ over the long-term and the full cycle.”
He continued: “Investor psychology — whether speculative or risk-averse — drives market outcomes over shorter segments of the market cycle. We read that psychology from the behavior of market internals.”
And, as the chart below shows, those internals have faltered since February. The blue line represents the cumulative total S&P 500 return in periods of uniform market internals. As you’ll note, the line has flattened recently — just as it did in the periods preceding the 2000 and 2007 stock market collapses.
This chart behavior is one of many factors that have Hussman forecasting an eventual drop of more than 65% for US stocks.
“Despite its discomfort, the market decline we observed in October is only a drop in the bucket toward normalizing valuations,” said Hussman. “Over the completion of the current market cycle, I fully expect the S&P 500 to lose close to two-thirds of its value from the recent peak.”
A self-aware approach to market forecasts
As always, the obvious elephant in the room must be addressed when discussing Hussman’s outlooks: He’s been calling for the equity market to lose two-thirds of its value for months — including well before the February correction. But it hasn’t happened yet.
Hussman thinks he knows why. He says the Federal Reserve‘s decision to lower interest rates to zero completely dismantled the role of valuations in signaling perilous market conditions. With monetary conditions so loose, companies and investors alike blew past warning signs that would’ve stopped them before.
“Unfortunately, the moment interest rates hit zero, those limits vanished, and preemptively responding to speculative extremes became terrifically detrimental,” said Hussman. “We can no longer rely on well-defined limits to speculation, as we could in previous market cycles across history.
He added: “In hindsight, the fix was simple: abandon the belief in any limit to the stupidity of Wall Street.”
It took him a while, but Hussman says he’s done this now. He’s instead fully focused on the aforementioned market internals and the extent to which they highlight shifts in sentiment.
Hussman even admits that — in the event of a recovery in market internals — he’s willing to adopt a neutral stance on the market in the near term.
Even though he’s arguably the biggest long-term bear around, everyone has their limits.
Hussman’s track record
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 has continued to grind mostly higher, he’s persisted with his calls, undeterred.
But before you dismiss Hussman as a wonky perma-bear, consider his track record, which he breaks down in his latest blog post. Here are the arguments he lays out:
- 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
- Predicted in 2000 that the S&P 500 would likely see negative total returns over the following decade, which it did
- Predicted in April 2007 that the S&P 500 could lose 40%, then it lost 55% in the subsequent collapse between 2007 and 2009
In the end, the more evidence Hussman unearths around the stock market’s unsustainable conditions, the more worried investors should get. Sure, there may still be returns to be realized in this current market cycle, but at what point does the mounting risk of a crash become too unbearable?
That’s a question investors will have to answer themselves. And one that Hussman will clearly keep exploring in the interim.