In his latest note, fund manager John Hussman says that even after the market decline the market is primed to fall some more.In mid-September, our estimates of prospective market return/risk dropped to the lowest figure we’ve observed in a century of market history (see Low Water Mark). That week turned out to be the high of the recent bull market, though it’s certainly too early to establish whether that was the ultimate peak. During the recent correction, I’ve noted a modest improvement in our return/risk estimates – which focus on a blended horizon looking out from 2-weeks to about 18-months. However, last week, the stock market experienced some significant damage to internals (breadth, leadership, price/volume measures, etc). As a result, our estimates of prospective return/risk have plunged lower again, to what is now the second most negative figure we’ve observed in a century of data – the September 14, 2012 weekly close of 1465.77 continues to mark the most negative estimate.
It’s tempting to assume that last week’s market weakness was nothing more than a post-election letdown for Wall Street, or a transitory focus on the “fiscal cliff.” But that perspective would ignore the months of extreme indicator syndromes that were in place well in advance of the recent weakness. As for immediate catalysts, Germany reported a significant miss in industrial production the day after the election, and the European Union downgraded its expectations for 2013 growth. Given the clear indication of European recession, the weakness in the “backstop” country significantly complicates the prospects that Germany will continue to bail out its neighbours or embrace the monetary equivalents of those bailouts. Here in the U.S., forward revenue guidance from companies was very weak in the most recent quarter, and leadership from a number of growth darlings has deteriorated abruptly (see the notes on exponential revenue growth in Release the Kraken for my views on the inevitability of such disappointments). Given our continued view that the U.S. is already in an unrecognised recession that began in the third quarter of this year, the “recognition” risks remain significant, and extend well beyond concerns about the fiscal cliff.
As I emphasised in September, the negative expected return/risk estimates we observe at present can’t be traced to some single extreme factor. For example, though corporate profit margins remain at the highest level in history, which make valuations look misleadingly reasonable, valuations are certainly less extreme today than they were in 2000 or even 2007. Bullish advisory sentiment has backed off from recent highs, and is certainly nowhere near its historic peak. The intermediate-term overbought condition of the market has also eased in recent weeks, and is nowhere near historic extremes. So again, our concerns are not based on some obvious, extreme indicator. Rather, these concerns are driven by the entire ensemble of indicators we use, taken together.
The present list of concerns includes rich (but not singularly extreme) valuations, coupled with unfavorable market action and a breakdown in market internals and trend-following measures, coming immediately after a seemingly endless series of hostile indicator syndromes (e.g. overvalued, overbought, overbullish). We call these syndromes “Aunt Minnies” – combinations of market conditions that may not be terribly important when observed individually, but that have almost always been followed by a specific outcome in subsequent market data when all of the conditions are observed simultaneously (see for example the October 8 comment Number Five).
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