Could historically high profit margins be the result of more foreign profits, making the high margins a new reality rather than anomaly? Fund manager John Hussman says the data says ‘no’.
Fund manager John Hussman has remained one of the staunchest bears in the stock market. And in a recent presentation (a tip of the hat to Business Insider for posting the presentation), he lays out his case for why the economy and market are not in as good shape as many believe.
Hussman says the Federal Reserve’s policies have created “an ocean of zero-interest monetary base” that “encourages a speculative reach for yield”. It has also created a deficit which must emerge somewhere else as a surplus (as per economic theory). And it has emerged, he says, in the corporate sector, where profit margins are far above historical norms. He says margins are mean-reverting, and when they do revert to their mean, profits will be hit hard. He sees stocks returning an average of about 3.5% annualized over the next decade.
“This fragile equilibrium that we’re in because of monetary policy, because of fiscal policy, and because of the combination of yield-seeking plus the appearence of yield through forward operating earnings because profit margins are elevated — this creates an environment where stock returns prospectively are very low,” Hussman said while giving his presentation at Mish Shedlock’s Wine Country Conference. “That’s really the point of QE,” he said. “It creates discomfort as a search for yield.”
Fund manager John Hussman remains quite bearish on the market, saying that stocks are showing signs of being in the “exhaustion” part of a bull market.
“We presently have an overvalued, overbought (intermediate-term), overbullish market featuring a variety of syndromes that have typically appeared in the ‘exhaustion’ part of the market cycle: elevated valuation multiples on normalized earnings, emerging divergences in market internals, an increasingly tepid economic backdrop, market prices near the upper Bollinger bands at monthly and weekly resolutions, and other factors that — taken in aggregate — have historically been associated with very weak average market outcomes,” Hussman writes in his latest market commentary (hat tip to Globe and Mail for highlighting the piece).
Hussman says that while valuations appear reasonable based on short-term measures of earnings, the data is misleading. “Presently, market cap is elevated because stocks seem reasonable as a multiple of recent earnings, but earnings themselves are at the highest share of GDP in history,” he says. “Valuations are wicked once you normalize for profit margins. Given that stocks are very, very long-lived assets, it is the long-term stream of cash flows that matters most — not just next year’s earnings. Stock valuations are not depressed as a share of the economy. Rather, they are elevated because they assume that the highest profit margins in history will be sustained indefinitely.”
Citing data from Ned Davis Research, Hussman says the stock market capitalization/GDP ratio is currently about 105% — higher than it was before the 1973-74 bear market and higher than it was before the 1929 market crash.
Fund manager John Hussman says he sees “extreme strains” ahead that many investors are underestimating.
In an excerpt from his most recent market commentary posted on Seeking Alpha, Hussman talks about how he missed some 2009 and 2010 upside “as we worked to make our approach robust to Depression-era outcomes”. Hussman says he thinks that will prove to be a good thing in the long run. “From a fiduciary perspective, I continue to believe that ensuring the ability to withstand extreme strains was necessary,” he says. “From a practical perspective, I continue to believe that the ability to withstand extreme strains will be more relevant in the coming years than investors would presently like to believe.”
Hussman also talks about why he doesn’t lift his hedges when the market surpasses a certain moving average and reinstate them when the market crosses below the average. He says that while the approach would seem to make sense on the surface, “if you actually take that strategy to historical data, the results typically aren’t nearly as compelling. Moreover, once any amount of slippage or transaction costs are taken into account, the most widely-followed strategies generally underperform a passive buy-and-hold strategy over time, and often don’t even manage downside risk particularly well.”
Hussman does talk about what types of trend-following strategies are useful. The key, he says, is using a strategy that employs a variety of factors. “Generally speaking, single indicators provide weak information because the true signal (whether about market conditions or economic prospects) is invariably confounded by random noise,” he writes. “The ability to infer signals from noisy observable data is typically enhanced by using a variety of indicators.” He says “market action should always be analyzed in the context of multiple indicators that capture a broad range of sectors, security types, yield-spreads, leadership, and so on. The information isn’t just in the obvious trends, it is also in the less obvious divergences.”
Fund manager John Hussman, whose funds have struggled in recent years but have good long-term track records, says he thinks the economy has entered recession.
“I noted two weeks ago that the leading evidence pointed to a further weakening in employment, with an abrupt dropoff in industrial production and new orders,” Hussman writes in his latest market commentary. He says there has been a “litany of awful figures” since then. “U.S. manufacturing new orders and export orders plunging from expansion to contraction, Eurozone new export orders plunging (only orders from Greece fell at a faster rate than those of Germany), and an accelerating decline in new orders in both China and Japan,” he says. Hussman also says the disappointing 80,000 jobs added to the economy in June may soon be a figure “looked on longingly”, as he expects job growth will turn negative within a few months.
Hussman says that many investors seem to be counting on the Federal Reserve to provide more quantitative easing, and thus haven’t been too rattled by the latest data. But, he says, a third round of QE isn’t likely to have nearly the impact earlier QE had. “In short, the effect of quantitative easing has diminished substantially since 2009, when risk-premiums were elevated and amenable to being pressed significantly lower,” he says. “At present, risk-premiums are thin, and the S&P 500 has retreated very little from its April 2012 peak. My impression is that QE3 would (will) be unable to pluck the U.S. out of an unfolding global recession, and that even the ability to provoke a speculative advance in risky assets will be dependent on those assets first declining substantially in value.” He also talks about what he thinks the real solution to the global debt troubles is — restructuring bad debt instead of rescuing it.
John Hussman, whose funds had strong long-term track records before getting hit hard the past few years, says those who contend stocks are cheap are way off base.
“I can’t emphasize enough how badly standard P/E metrics are being distorted by record (but reliably cyclical) profit margins, which remain about 50-70% above historical norms,” Hussman writes in his latest market commentary. Hussman says valuations are actually more elevated than they were before the 2008 market plunge when margins are accounted for. Stocks are priced to return just 4.5% annually over the next decade, he says.
Hussman also talks about why he thinks the economic outlook is worse than many believe. But, he adds, “Emphatically, however, our concerns about the stock market continue to be independent of these economic expectations, as the hostile investment syndromes we’ve seen in recent months have historically been sufficient to produce very negative market outcomes, on average, even in the absence of economic strains. As always, I strongly encourage investors to adhere to their disciplines — including those following a buy-and-hold approach — provided that they have carefully contemplated the full-cycle risk and their ability to stick to their strategy through the worst parts of the investment cycle. What I am adamantly against is the idea that speculators can successfully ‘game’ overvalued, overbought, overbullish markets — particularly in the face of numerous hostile syndromes, near-panic insider selling, speculation in new issues, and broad divergences in market internals, all of which we are now observing.”
Last week, we noted how The Wall Street Journal’s Jason Zweig says that we’re in the best time ever for individual investors, thanks largely to the way fees have declined and the ease of obtaining information has increased over the years. This week, however, John Hussman argues that, in terms of the specifics of the current market conditions, it’s one of the worst times ever to invest.
“This is not a runaway bull market,” Hussman, whose funds have solid long-term track records but have stumbled in recent years, writes in his latest market commentary. “Rather, it is a market that again stands near the highs of an extended but volatile trading range. I am convinced that the breakdown of the market from this range has been deferred only through repeated and extraordinary central bank actions.”
Hussman says the current market is characterized “by an extreme set of conditions that we’ve previously associated with a ‘Who’s Who of Awful Times to Invest,’” citing the 1972-73 and 1987 market peaks and several occasions since 1998. Hussman says that when similar conditions have occurred in the past, they’ve been followed soon after by moderate and/or severe declines. In the past couple years, however, that trend has stopped, and he says it’s largely because of central bank efforts to bolster markets.
Hussman says it is critical for investors to remain defensive, despite the rising market. “It’s easy to underestimate how utterly excruciating it is to remain hedged during these periods when you actually have to live through day-after-day of advances and small incremental new highs that are repeatedly greeted with enthusiastic headlines and arguments that ‘this time it’s different,’” he says, adding, “The completion of the present bull-bear market cycle (and it will be completed) will undoubtedly present strong opportunities to play offense, but today stands among a Who’s Who of the worst historical times to do so. Particularly for investors who do not have a large number of future cycles between now and the point they will need to draw significantly on their assets, a defensive stance is crucial here.” He adds, however, that “our present defensiveness is unlikely to persist a great while longer.”
A couple reasons for Hussman’s bearishness: He says that arguments about stocks being cheap based on forward earnings fail to take into account unsustainably high levels of profit margins, and that they compare those P/Es to “bubble-era norms”. He also looks at a variety of economic indicators that he says are pointing toward trouble.
Fund manager John Hussman says the current stock market condition “warrants unusual concern,” and is playing defense with his portfolio.
“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,” Hussman writes in his weekly market commentary. “This places us in a tightly defensive position.” Hussman says conditions could change rather quickly, but right now he sees “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.”
Hussman estimates that based on current valuations, the S&P 500 is priced to return about 4.8% annually for the next decade. He says they may very well beat Treasury bonds over that period, “but for investors who have any sensitivity to price volatility, that is likely to be a small comfort in the next few years.”
As for Europe’s debt crisis, Hussman thinks recent optimism is overdone. “Last week’s events took a great deal more off the table than sugar-addicted investors may immediately appreciate,” he says. “In effect, if a fiscal union is achieved without treaty changes, the ECB is unlikely to act. But even if treaty changes are achieved, the ECB is unlikely to act forcefully unless those changes are credible. Of course, if the changes are credible, then forceful actions will not be needed anyway. In any event, the problem for bailout-hungry investors is that they will be deeply disappointed if they expect Mario Draghi to turn into Ben Bernanke.”
Hussman also gives his take on what might help Europe, and why he’s not positioning his portfolios to catch a “Santa Claus Rally”.
Fund manager John Hussman says a new recession — and a Greek debt default — are now “virtually certain”.
In his latest market commentary, Hussman says that the markets seem to be viewing the current situation as a replay of the 2010 correction, and are holding out hope that the Federal Reserve will launch another round of “monetary intervention”, as it did when growth slowed in 2010. That won’t help matters, however, he says. “While we have to allow for the possibility of a knee-jerk speculative response in the event of further Fed intervention, it is also much clearer now than it was in 2010 that quantitative easing does not work, and that even its marginal effects have reached the point of diminishing returns,” he writes. “To a large extent, the only basis for further Fed action here is superstition in the absence of either fact or theory.”
Hussman says another round of QE would fix a problem that doesn’t exist; there’s plenty of money in the system already, he says — the problem is that $1.6 trillion of it is “sitting idle” as excess reserves in the banking system. He also says that another option, increasing the maturity of the Fed’s portfolio to further drive down long-term interest rates, would have a similar non-impact. Companies aren’t investing right now not because interest rates aren’t low enough, he says. “Most of the reluctance to invest here is because there is already enormous slack capacity, and even for new products, there is generally great uncertainty as to whether there will be robust demand for the output,” he writes. “The Fed is kidding itself if it believes that a slight further reduction in long-term Treasury yields will matter in that calculus.”
Top fund manager John Hussman remains quite bearish on the broader market, saying that investors who try to ride the market’s recent momentum are getting close to “ensur[ing] themselves maximum damage”.
“We’ve certainly made our own adaptations to improve our ability to ‘go with the flow’ with a greater frequency, even in markets that appear objectively overvalued from a long-term perspective,” Hussman, who has a strong long-term track record but has missed out on much of the current rally, writes in his latest market commentary. “Still, whatever constructive opportunities there might have been in 2009 and early 2010 are now well behind us. We are close to the point where investors can ensure themselves maximum damage by shifting away from a defensive stance and buying the market, in hopes of reaching for return in an already richly valued and overextended advance.”
Hussman says he’s expecting the broader market to return 3.5% to 4% per year in the coming decade, but adds that those average returns could be the result of big short-term swings, “so a poor long-term expectation doesn’t rule out the likelihood of significant investment opportunities in the interim. The real difficulty at present is that at already elevated valuations, it’s less likely that those opportunities will be front-loaded.”