- By an increasing number of measures, US equity valuations are at their highest on record.
- John Hussman, the investor and former professor, doesn’t think this is a sustainable situation, and he forecasts that stocks will lose two-thirds of their current value.
- Hussman is an outspoken market pessimist who has sounded the alarm on equity valuations repeatedly in recent months.
- He argues that while psychological factors can keep valuations high in the near term, the long-term forecast for the market will involve an unavoidable major sell-off.
One of the stock market‘s most outspoken bears is at it again.
That would be John Hussman, the former economics professor who is now president of the Hussman Investment Trust. He has been soundingthealarm for months on what he forecasts will be a catastrophic equity sell-off, and his warnings are only getting more forceful.
This time around, Hussman is calling for the benchmark S&P 500 to lose 67% of its current value. That would bring the index from roughly 2,862 down to 950, a truly eye-popping level considering the index’s seemingly unstoppable streak of gains.
“I expect that the S&P 500 will lose approximately two-thirds of its value over the completion of this market cycle,” Hussman wrote in a recent blog post.
His rationale for the sell-off is one he has cited with each subsequent forecast: Stock prices have simply gotten too extended. And while Hussman has a war chest of valuation metrics he monitors, the one that just recently hit record highs is a measure of nonfinancial market capitalisation, relative to corporate gross value-added (see below).
The market bloodbath that Hussman is forecasting will be so bad, in fact, that one of investors’ favourite tactics – buying the dip – will be numb to its power.
“My impression is that the first leg down will be extremely steep, and that a subsequent bounce will encourage investors to believe the worst is over,” he said. “Study market history. The trouble rarely ends until valuations have approached or breached their long-term norms.”
Still, Hussman’s forecasts must be absorbed with the ultimate caveat in mind – his doomsaying predictions have yet to come true, even though he has been making them for months.
His explanation for this is straightforward: He’s referring to a longer-term cycle, and while the market has remained resilient in the short term, it must eventually buckle, he believes.
Hussman argues that when sentiment and psychology – rather than fundamentals – are driving the market higher, prices can increase for some time, but the end result is always some sort of crash. And in the case of this most recent run-up to record highs, he cites the Federal Reserve‘s easy monetary policy as having emboldened traders.
“Aside from an occasional bit of lip-service, followed by reassuring justifications, investors entirely dismiss the level of valuations when they have the speculative bit in their teeth,” he wrote. “Recognising that valuations matter profoundly over the long run, yet are nearly useless over the short run, is central to navigating complete market cycles.”
But Hussman isn’t one to offer such a pessimistic forecast without a solution. For those looking for protection, he recommends tail-risk hedges that kick in automatically as the market declines, rather than trades that require the completion of sell orders.
“I believe that it’s essential to carry a significant safety net at present,” he wrote. “Breathtaking valuations are followed by dismal consequences.”