Legendary US-based fund manager John Hussman has long been saying that the pricing in stock markets was elevated and that as a result of relatively high valuations investors could look forward to lower returns in the next decade.
In his Weekly Market Comment this week Hussman explained that the lesson of more than a century of market price action and cycles is that:
Valuations are the main driver of long-term returns, but the main driver of market returns over shorter horizons is the attitude of investors toward risk.
Depending on what the market internals look like will depend on whether bad news can be ignored or, like the last week,”overvaluation can suddenly matter with a vengeance.”
Ominously he says that last week’s sell off, which saw the Dow and S&P 500 lose close to 6% and the Nasdaq lose almost 7% “was actually a rather run-of-the-mill example” of the type of moves that has followed similar “market conditions”.
But it is perhaps in seeking to distinguish between the causes of and trigger for last week’s move that Hussman gets to the nub of how persistent the selling could become.
If you roll a wheelbarrow of dynamite into a crowd of fire jugglers, there’s not much chance things will end well. The cause of the inevitable wreckage is the dynamite, but the trigger is the guy who drops his torch.
What he is getting at is that it is monetary policy, in this case from the US Fed, which has driven the overvaluation in stocks which is ultimately the “cause”, his wheelbarrow full of dynamite, of selling. But the trigger, his fire juggler, is the weakness in the data that brought valuations into focus.
My impression is that trigger of last week’s market loss was not China’s yuan devaluation or even concern about the potential for a Federal Reserve rate hike. Rather, the trigger was most likely the sudden deterioration of leading economic measures, energy prices, and industrial commodities, both in the U.S. and globally. This weakness first became evident in February. After a brief rebound, the data has deteriorated abruptly once again. While extraordinary monetary interventions across the globe have certainly distorted the financial markets, they have done little to support the real economy, and developing economic weakness in the U.S. and abroad is beginning to clarify that ineffectiveness.
Now the juggler has been found Hussman expects “the S&P 500 to decline by 40-55% over the completion of the current market cycle.”