John Hussman: The Market Is Not in Uncharted Territory

by: John Hussman November 17, 2008 | about stocks: DIA / QQQQ / SPY    
John Hussman

John Hussman

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Excerpt from the Hussman Funds' Weekly Market Comment (11/17/08):

If we seriously need to talk about the Great Depression (I personally believe that it is an outrageously dire comparison), we should recognize that even during that prolonged decline, it rarely made sense to sell into a major break of a previous low, because investors invariably had a chance to sell on a later recovery to the prior level of support. Below is a chart of the Dow Jones Industrial Average during the Depression. Even if one hung on after the enormous rally of nearly 50% that followed the initial 1929 low, the market's initial break of that low (the first horizontal bar) was followed several months later by a rebound to that prior level of support. The break of the second intermediate low of early 1931 (the second horizontal bar) was followed by a rebound later in the year to that same level. Third break, same story.

It is a typical market dynamic to have massive rallies toward prior levels of support, even within ongoing market declines. Once valuations are favorable, that tendency is even stronger, even in a weakening economy. Only the final panic decline of a bear market offers investors virtually no chance to get out on rebounds, but it is precisely that final decline that is recovered almost immediately in the subsequent bull market.

...

Even if the U.S. economy experiences a much deeper recession, I believe that the 1000-1100 level on the S&P represents a reasonable estimate of “fair value” for the S&P 500. That estimate is somewhat conservative since I am adjusting for the fact that earnings in recent years have been based on very wide profit margins, but could be too conservative given that long-term interest rates are very low. Long-duration instruments like stocks should not be priced off of short-duration instruments like 10-year Treasury bonds, or even 30-year Treasuries, so low interest rates shouldn't make investors recklessly optimistic about their valuation estimates. In any event, I do believe that current levels represent value from the standpoint of long-term investment prospects.

As for extreme and less likely benchmarks, the 780 level on the S&P 500 would represent a 50% loss from the market's peak, and would put the market in the lowest 20% of all historical valuations. I would expect heavy demand from value-conscious investors about that level if the market was to decline further, and a decline below that level could be expected to reverse back toward 780 fairly quickly. Further down, but very unlikely at this point from my perspective, the 700 level on the S&P 500 would represent the lowest 10% of historical valuations, 625 would put the market in the lowest 5% of valuations, and anywhere at 600 or below would put the market in the lowest 1% of historical valuations. I don't expect to see such a level, but there it is. Note that these estimates are unaffected by how low earnings might go next quarter or next year. Stocks are not a claim on next quarter's or next year's earnings – they are a claim on an indefinite stream of future cash flows.

Recent market conditions seem like they have no precedent only because so many investment professionals know only the data they've lived through. If one actually examines market data from the Great Depression, 1907, and other less extreme panics, one realizes how much the recent decline has already discounted potential economic negatives. At this point, further declines in stock prices simply increase the long-term returns that investors can expect over time. We can't rule out the possibility that investors could get more frightened, or that they might abandon their stocks at prices that would offer extremely high long-term returns to the buyers. It is important to establish exposure slowly, but long-term investors who ignore attractive valuations are not investors at all.

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This article has 33 comments:

  •  
    Nov 17 04:03 PM
    the problem is that this market has turned everyone into day-traders
    Reply | Link to Comment
  •  
    Nov 17 04:26 PM
    Good article. AS you say, who knows, perhaps there really IS a major depression waiting out there...but to be honest, what is scaring most of these fancy pants traders is they think a 'bear market' is a one month 10% correction followed by a surge to new highs!

    Welcome to the real world folks..I remember the 45% decline in the early 70s. Thats a real bear market, and its a lesson todays investors need to learn.
    Reply | Link to Comment
  •  
    Nov 17 04:30 PM
    The real problem is that it's only day traders left in the market. Big government collusions with NYC/Wall St. creates an encapsulation effect. If our economic system is dying it's common sense to ask the chicken and the egg question (does the consumer create a stock market or does the stock market create the consumer). When one answers that question honestly one comes to an easy conclusion of what must be done to restore our economy.
    Reply | Link to Comment
  •  
    Nov 17 04:44 PM
    No fundamental as well as technical analysis applies to the current "Once in a Century" crisis. Almost all of them were based on documented data that have enough repeated occurence to be statistically relevant. The current crisis happened or is happening only for the first time in a century. No statistical data is going to be of any relevance if it happens only once.

    Dow Jones has extremely high probability of finalyzing the 100-year chart into an expanding flat with 4750 target using Elliott Wave analysis. Expanding flats are very common patterns you can see on intraday as well as daily or weekly charts. MER is an expanding flat on the quarterly or yearly chart with $9 target. MER is already in the advanced stage while Dow Jones is half-way thru.

    However, looking at the century chart of Dow Jones; there is also a 50% probability that the expanding flat C wave will over-extend into the 700-1000 range of the 1965 to 1980 range where the Dow kept on failing to break the 1000 ceiling for 15 years.

    If Dow ever gets into that range and stays there for several months; it will be catastropic that is going to destroy not only everybody's wealth but confidence of the future.

    Only a massive rally after 4750 or 700-1000 whichever bottom happens will the stock market be able to restore confidence.

    Without a searingly hot rally that will be able to recover Dow Jones 14,200 level of Oct 2007 within 5 years from bottoming; there will be a prolonged market consolidation that will double or triple the amount of time that has been consumed so far in order to repair the numerous damages inflicted by the destruction of wealth.

    Remember, the plunge of 1929 to 1932 correction was able to produce more than 10 years of depression.

    One look at SnP500 double top pattern on the yearly chart shows that we are already going into a correction process for almost 8 years starting year 2000. Expected bottom is H2 2009.

    How many years of economic depression will a stock market correction that has been going on for 9 years be able to inflict into the economy?

    There are a lot more Americans who are directly and indirectly affected financially by the stock markets today than there were in 1932.

    Likewise, stock markets of the 1932 was a lot less global in nature. Now, we have stock markets and their corresponding economies that will inflict damage to the US with US likewise inflicting damage to other countries in significant ways.

    Even China, Russia and Brazil which were considered immune to market downturns are now economically suffering due to the severe impact of the US and European downturns.
    Reply | Link to Comment
  •  
    Nov 17 04:50 PM
    That's a very interesting chart John. I thought I noticed something and just checked out my suspicion. Are you aware that the size of successive bounces follows a logarithmic pattern? That implies you can well predict the maximum up-tick at the start of each bounce..
    Reply | Link to Comment
  •  
    Nov 17 04:54 PM
    Thank you, John Hussman. I appreciate your analysis.
    Reply | Link to Comment
  •  
    Nov 17 05:19 PM
    I read John Hussman's commentary on his funds' web site on a regular basis. He is one of the few money managers (and analysts) who can rightly claim, "Told you so!"

    His strategy of holding high quality stocks, combined with hedging against market revaluation using SPX Put options has paid off handsomely this year, making his fund one of the most successful in the industry. This is even more impressive considering it has lower risk than the market.
    Reply | Link to Comment
  •  
    Nov 17 05:47 PM
    I love these TA guys who claim to be able to divine the future from a chart full of squiggles. If you can tell which way the chart will squiggle next based on how it squiggled in the past, why aren't you a billionaire by now? And did any squiggle-people predict the current bear market? I'm sure someone did, since squiggle-reading is as subjective as tea leaves. Oh well, it beats learning about economics and accounting!
    Reply | Link to Comment
  •  
    Nov 17 05:54 PM
    If "great depression" means we are all greatly depressed, we're there...
    Reply | Link to Comment
  •  
    Nov 17 06:05 PM
    one word 520 on the spx
    Reply | Link to Comment
  •  
    Nov 17 06:07 PM
    John has put up a good article and aarc comments are also insightful. Based on the spectrum of opinion, each trader/investor formulate his own strategy. aarc has covered the more extreme outcomes like Dow 5k or even Dow 1k but because there is some logic and probability in this argument we cannot simply write it off as fantasy. Let the market lead us although this is easier said than done, as difficult the wise saying buy low sell high or John's advice to buy low into weakness for the longer term.
    Reply | Link to Comment
  •  
    Nov 17 06:11 PM
    Dr. Hussman, as usual, is right on. We need more fund managers like Dr. Hussman who is dedicated to his craft.

    If this is truly the end of the world, your stock portfolio is the last thing you need to worry about.
    Reply | Link to Comment
  •  
    Nov 17 06:18 PM
    If today's market rolls over into another Great Depression (which I doubt), I a more long-term strategy is excellent for portfolio risk management. I follow a 10-month moving average timing signal on the monthly close. Here's a daily chart of the Dow from October 1928 to January 1935:

    dshort.com/charts/Dow-...

    Here's a monthly chart over the same timeframe with some 10MA signals:

    dshort.com/charts/Dow-...

    This monthly MA strategy is not suitable for long-term sideways markets (and it certainly won't be of interest to a mutual fund manager). But it has worked reasonably well since the mid 1990s. It would have saved a lot of pain in 1929-1932, and it would have moved your to fixed income in November of last year.
    Reply | Link to Comment
  •  
    Nov 17 06:41 PM
    Very interesting of looking at the declining stuff:

    You can also argue that you can sell on the lows only to wait some time longer to buy stock back at far lower levels and wait for another low trigger in order to sell.

    And after that waiting a long time to buy stuff back far more cheaply...

    But living day to day we do not know if we are at a bottom... We do not have fancy 1929 charts, all we know stuff is declining.

    Come on face the facts and abandon all this fancy technical analysis:

    For the first time in history the S&P 500 is negative on a 10 year scale, it has never ever happened before that an investment in the S&P 500 was negative.

    Beside being negative, you have a full fist of inflation in your face so in fact it is far worse than 'only being negative on a 10 year scale'.

    I don't know what a full decade of the last inflation was but we can safely conlude that 100 US$ invested a decade ago in the S&P 500 is now below 70$... (in 1998 US$ of course).
    Reply | Link to Comment
  •  
    Nov 17 06:44 PM
    I hope the next link to the Yahoo S&P 500 for a decade works, if not try to find it yourself:

    finance.yahoo.com/echa...=^gspc;range=19981117,...
    Reply | Link to Comment
  •  
    Nov 17 06:45 PM
    No, it does not work.

    So fill in the date (17 Nov 1998) for yourself in the box at the right lower bottom of the Yahoo S&P chart...
    Reply | Link to Comment
  •  
    Nov 17 06:47 PM
    aarc first says: "No fundamental as well as technical analysis applies to the current "Once in a Century" crisis."

    Then aarc says: "Dow Jones has extremely high probability of finalyzing the 100-year chart into an expanding flat with 4750 target using Elliott Wave analysis."

    HUH? If technical analysis doesn't apply, then why are you applying it????????? Ridiculous.
    Reply | Link to Comment
  •  
    Nov 17 06:53 PM
    Good analysis. It will be interesting to see which way we break out of this trading range. The interesting thing about this bear market is that we have reached approximately same levels as the other brutal bear markets but in far shorter time- I have no idea whether this means we will recover faster. Like most technical analysts, I will react accordingly when we get a good confirmation.

    Considering the season and the fact we have not seen a decent rally, even a bear market rally, in some time, I would suspect that the indexes would at least rise and test their respective 50 day moving averages for a tradeable rally.
    Reply | Link to Comment
  •  
    Nov 17 06:59 PM
    First of all, Does anybody know why Seeking Alpha now requires two Google Corporation scripts to be run in your browser in order to post on Seeking Alpha?

    Both of the scripts being run by the Google Corporation on Seeking Alpha have been flags as unsafe by my computer security software.

    There is another script that is also being run by Seeking Alpha from nuconomy.com that is flagged by security protection software as a privacy concern. Now I have to use a computer at an Internet cafe to post on their computers. Crazy!

    Is Seeking Alpha now violating privacy of posters, or reporting back to Paulson, Pelosi and Frank who is posting what against them? LOL!

    In any case... The stocks will continue to fall and fall until they have lost maybe 75-80 percent of what they were worth in 2007. And, to directly attack your position, the markets have NEVER been in this position before. Never, in the history of our country, or the world, have economies been so complex and interdependent on one another. It will be a catastrophic disaster when this sucker goes down.

    Take a step back, away from your numbers and data to look at the game (I'm big on game theory). What do you have?

    1. Consumer countries (USA Number One).

    2. Manufacturing Countries

    3. Raw material (resources) and agricultural countries.

    In this game, how do you think it will play out every time? If you guessed the consumer country will falter, fall into debt and collapse, you'd be correct.

    Then we had this twist on the game:

    The United States actually figured out a way to take the debt we owed countries and then convinced them that it would be a great future investment. Countries like Japan and China bought it! LOL! I don't think they'll be that stupid in the next round...

    You'll know that you've reached bottom when there is gunfire in the streets and the talking heads are committing suicide after being surrounded by angry mobs. I think the leaders of the public and private sectors are getting ready to be in a situation where the country and world will be like New Orleans after Katrina, but nobody is going to be there to help. Their security details, as I'm sure they've been told, will be useless or abandon them.

    This sucker's going down. I give it three to six months.
    Reply | Link to Comment
  •  
    Nov 17 07:15 PM
    if "this sucker's going down" everyone is toast. you included, my friend.
    Reply | Link to Comment
  •  
    Nov 17 07:26 PM
    chrisb,

    Your comments regarding the futility of TA are amusing. "And did any squiggle-people predict the current bear market?" Yes, many did. But most of them wouldn't bother telling you about it. Unfortunately, you still think you understand what technical analysis is by reading about it from a Wikipedia page while eating a sandwich. It takes time to learn the art behind the science; in time you'll see the charts in a completely different way. This is about as kind a message as I can proffer considering that I gain nothing by telling you this. If you must know, this year I "used the squiggles" to:

    - short gold (DZZ) at $970/ounce;
    - short Encana (ECA) at $92/share;
    - buy SKF at $89/share (more than once);
    - short Goldman (GS) at $137/share;
    - short crude oil (HOD.TO) at $119/barrel;
    - sell CAD against USD at parity;
    - short SPY at 130.00/share (via SDS); and last but not least
    - short BRK/B at $4390/share.

    The list goes on. How many long-side trades do you see? I've only been doing this for 18 months and my measly initial couple of hundred grand bankroll isn't big enough to crack the billion mark yet; this and this alone is the reason that I'm writing you--I'm still in the market. My 135% year to date return, however, suits me just fine. Doubt me? Send me your postal address and I'll fedex you my trade tickets. Take this advice: keep your toilet shut before discounting a method you know absolutely nothing about.
    Reply | Link to Comment
  •  
    Nov 17 07:29 PM
    icandoitdon:

    That's right. We are ALL TOAST.

    Why do you think all of these people are buying ammunition and firearms? Becuase Obama will regulate weapons? No way. People are getting ready for what's going down.

    I've traveled some in the past few weeks and every store I went to has empty shelves big time. Week, after week, the grocery and box stores have fewer and fewer items. Huge gaps in shelves for everything...

    The last time I saw something like this was during the Cuba Missle Crisis, but it's interesting how the media is not reporting on the empty shelves at grocery stores. I've personally seen this in several Southern and Western cities I've visited... Empty shelves or a total lack of stocked items...

    It is getting crazy. I've been asked by some neighbors if I wanted to join a community security group, since police will be worthless.

    My take on all of this, icandoitdon, is that when this sucker goes down. We all ARE TOAST.
    Reply | Link to Comment
  •  
    Nov 17 07:29 PM
    Great graphs 70s stag survivor

    I think we're at the same level of nov'29 where it rebounded off 200, though now that level should be 800.

    Prob have a rebound, especially with a new president, new policies, new hope (the audacity of hope), before fizzling out as we discover more and more bad debts - which will be coming from various sources not yet taken into estimates.

    Its gonna be painful... - the repricing of risk, rising bankruptcies, increasing unemployment.

    I hope not a depression again, but its gonna be tough!
    Reply | Link to Comment
  •  
    Nov 17 07:44 PM
    Curbs-in,
    You must be a multi-millionaire??

    With your predictions you must have been & are still invested 100%
    in the double bear ETF's.
    Reply | Link to Comment
  •  
    Nov 17 08:30 PM
    Jase,

    Congrats on your 8 good trades and your high YTD return.
    Why do you think that any of this has something to do with TA?
    I don't know what your exact method is, but most TA methods I'm familiar with are an attempt at pattern recognition. Human brain is very good at confirmation bias. If you already believed that gold was "expensive" your TA would always confirm it.
    Do you believe that you can establish cause and effect based on 8 trades? Have you closed all of them yet? My guess is no, since you are still in the market.
    You seem to believe that making these kinds of returns is easy.
    I guess if it's so easy you have probably already quit your day job.
    I guess it must be easy for you but impossible for the rest. What makes you so special? I know we are all special, but seriously?

    Good luck climbing the easy money mountain!

    On Nov 17 07:26 PM Jase wrote:

    > chrisb,
    >
    > Your comments regarding the futility of TA are amusing. "And did
    > any squiggle-people predict the current bear market?" Yes, many
    > did. But most of them wouldn't bother telling you about it. Unfortunately,
    > you still think you understand what technical analysis is by reading
    > about it from a Wikipedia page while eating a sandwich. It takes
    > time to learn the art behind the science; in time you'll see the
    > charts in a completely different way. This is about as kind a message
    > as I can proffer considering that I gain nothing by telling you this.
    > If you must know, this year I "used the squiggles" to:
    >
    > - short gold (DZZ) at $970/ounce;
    > - short Encana (ECA) at $92/share;
    > - buy SKF at $89/share (more than once);
    > - short Goldman (GS) at $137/share;
    > - short crude oil (HOD.TO) at $119/barrel;
    > - sell CAD against USD at parity;
    > - short SPY at 130.00/share (via SDS); and last but not least
    > - short BRK/B at $4390/share.
    >
    > The list goes on. How many long-side trades do you see? I've only
    > been doing this for 18 months and my measly initial couple of hundred
    > grand bankroll isn't big enough to crack the billion mark yet; this
    > and this alone is the reason that I'm writing you--I'm still in the
    > market. My 135% year to date return, however, suits me just fine.
    > Doubt me? Send me your postal address and I'll fedex you my trade
    > tickets. Take this advice: keep your toilet shut before discounting
    > a method you know absolutely nothing about.
    >
    Reply | Link to Comment
  •  
    Nov 17 08:54 PM
    Do what I've done and talk to some elderly people who were around for the real Great Depression. Every last one of them LAUGHS at the talk comparing now to then. It's a joke they say, to compare this credit bubble, to now.

    Cyclingscholar - If you do the math on DOW 14K to 8K, I believe that's in the neighborhood of 40% or so. Comparable to the '70's saga you brought up.

    Speaking of the 1970's, we're in for a real round of inflation, and it's going to get ugly. Debt will be worth-less, assets will surge, get ready.
    Reply | Link to Comment
  •  
    Nov 17 09:47 PM
    What is it that prompts an investor to buy stock?

    Future sales and earnings are the usual reasons, right? And, considering that dividends are becoming more rare these days, price appreciation of stock is the only return an investor receives on what is typically the riskiest of all investments. I don't remember seeing spectacular sales or earnings results from any sector other than financials or commodities recently.

    Buy and hold if you must but be prepared to go really long. And, if the inflationistas are correct, you're never going to realize a true ROI - not in this lifetime anyway.
    Reply | Link to Comment
  •  
    Nov 17 10:29 PM
    The subtle implication of your post is that you are somehow smarter than Jase to be able to call out his hubris and make a judgment call on his trading methods. To do that, you would have to know more about TA than Jase claims to know, which is in direct opposition to the thrust of your post which is that Technical Analysis is at best foolish.

    If one desired, you could find some fairly good buy and sell signals with just a 40 week moving average, and a Relative Strength chart comparing a particular issue to the broader indexes. That right there would have put you in cash, or suggested short positions at the right times this year.

    You do have to be pretty special to be a chartist/TA trader. You have to have some discipline and commitment, which is actually pretty rare to come by these days.

    On Nov 17 08:30 PM Vladimir Senkov wrote:

    > Jase,
    >
    > Congrats on your 8 good trades and your high YTD return.
    > Why do you think that any of this has something to do with TA?<br/>I
    > don't know what your exact method is, but most TA methods I'm familiar
    > with are an attempt at pattern recognition. Human brain is very good
    > at confirmation bias. If you already believed that gold was "expensive"
    > your TA would always confirm it.
    > Do you believe that you can establish cause and effect based on 8
    > trades? Have you closed all of them yet? My guess is no, since you
    > are still in the market.
    > You seem to believe that making these kinds of returns is easy.<br/>I
    > guess if it's so easy you have probably already quit your day job.
    >
    > I guess it must be easy for you but impossible for the rest. What
    > makes you so special? I know we are all special, but seriously?<br/>
    >
    > Good luck climbing the easy money mountain!
    >
    > On Nov 17 07:26 PM Jase wrote:
    Reply | Link to Comment
  •  
    Nov 18 12:34 AM
    The world in 1929 was completely different. Yoiu did not have huge emerging economies like China, India, Brasil. We're much more resilient.
    I don't believe charts from the 1920's, 30's or even 70's are that useful.
    Reply | Link to Comment
  •  
    Nov 18 01:06 AM
    vladimir,

    It's difficult to respond to your post as your initial comments are "I don't know what your exact method is, but..." then the remainder of your diatribe goes on to challenge what you imagine my method to be.

    What shall I comment on--the actual methods that I use or the words that you've put in my mouth?

    When you elect to pelt me with comments like: "You seem to believe that making these kinds of returns is easy" and "Do you believe that you can establish cause and effect based on 8 trades?" and "I guess it must be easy for you but impossible for the rest", it suggests to me that you're having a conversation with yourself, not me.

    Here's the spill:

    1. The eight trades that I listed weren't the only trades that I've made this year, there were many more trades, and many, many were losers. Each losing trade, however, incurred a maximum loss of 6% on only a partial initial position size. In other words, if I intend to commit a total of $100,000 to a position, I will never lose more than $1800 plus commissions. No exceptions. I add to all successful positions using very strict guidelines and I'm not afraid of taking partial profits.

    2. Yes, I do this full-time. I lost $30M earlier this year when the financing for my software company fell through (investment bank went tits up due to subprime exposure, among other things). The capital that I use to trade is all that I have left in this world--so I take trading very, very seriously.

    3. I don't care about profits. All I care about is managing risk.

    4. I have patience. More than 70% of my gains are realized in the last 20% of the time that I hold my positions. I'm still working at mastering the skill of sitting still; this is really, really hard. That said, I've been taking profits much more quickly during October and November. I'm sitting in a relatively high % cash right now.

    5. Yes, I'm still in the market. Of the eight trades that I've mentioned, I'm still holding the BRK/B short, still holding USD against CAD, and I'm still short crude oil... there are a few others.

    In your comments, you used the word "believe" several times. I don't trade what I believe. Frankly, the market doesn't give a shit what I think. I only trade what's right there in front of me, what I'm seeing occur. If a trade isn't going my way and I'm stopped out (100% of my