A notorious market bear who called the 2000 and 2008 crashes warns stock valuations are near their most elevated levels ever — and lays out why a 63% decline in the S&P 500 would be consistent with 100 years of history
- According to John Hussman, the S&P 500 could fall by 63%.
- Hussman recently stated that such a drop would be consistent with historical norms.
- Hussman predicted the stock market crashes of 2000 and 2008.
When John Hussman discusses stock market valuations, he frequently uses his own metrics. This is because they are frequently correct in identifying when stocks are in bubble territory.
Hussman, the president of Hussman Investment Trust who predicted the 2000 and 2008 crashes, says his preferred metric is total market capitalization of non-financial stocks divided by total gross value added of those stocks. The S&P 500 is currently trading at levels higher than during the dot-com bubble.
Hussman also likes his version of the equity risk premium, which estimates the excess return investors can expect from stocks over risk-free Treasury bonds. With stock valuations high and 10-year Treasury yields well above 4%, investors can expect a relatively low premium from stocks. Hussman’s model predicts that the S&P 500 will underperform Treasurys by 7.5% over the next 12 years, the lowest projection since the 2000 and 1929 bubbles. Actual S&P 500 performance tends to closely track Hussman’s projections.
However, even more commonly used investor measures show that valuations are historically high. The Shiller cyclically adjusted price-to-earnings ratio for the S&P 500, which averages valuations over the previous ten years, is shown below. At 20, it’s close to some of the highest levels ever recorded. In red is the index’s 12-month forward price-to-earnings ratio. While it has a shorter history, it closely tracks the CAPE ratio in reverse.
Historically, when stock valuations have been this high, things have not gone well for investors. The S&P 500 would have to fall significantly for stocks to return to levels where investors can expect higher annual returns than Treasury yields.
“Based on prevailing market valuations, we estimate that poor total returns are likely for the S&P 500 in the coming 10-12 years, that equity market returns, relative to bonds, are likely to be among the worst in history, and that a market loss on the order of -63% over the completion of this cycle would be consistent with prevailing valuations and a century of market history,” he said.
The chart below shows how far the S&P 500 would have to fall to regain various levels of excess returns over Treasury yields. To achieve even returns, the index must fall 42% to 2,630. Of course, yields could fall significantly as well, but factors such as the Federal Reserve policy rate and increased government bond issuance make this a risky prospect.
Hussman is concerned about poor investor sentiment in addition to high valuations. According to him, the combination has typically resulted in a “trap door” scenario in which stocks suffer steep losses. Hussman gauges sentiment by examining the consistency of asset outperformance in stocks and bonds. His indicator (shown in red) is currently relatively flat, which has historically meant bad news for stocks (shown in blue).
Hussman’s track record — and his views in context
Since October 2022, the S&P 500 has risen 27% as investors have grown increasingly confident that the Fed’s hiking cycle will end with a soft landing. The so-called “Magnificent 7” stocks, the S&P 500’s top seven by market capitalization, are responsible for a large portion of those gains. However, market breadth has recently begun to improve as the economic picture appears to be improving in some ways.
“Participation in the current recovery has improved significantly in recent weeks, indicating that this is more than just a ‘Magnificent Seven’ story.” In a recent note, Adam Turnquist, chief technical strategist at LPL Financial, stated, “As of yesterday, 55% of S&P 500 stocks closed above their 200-day moving average, more than doubling since the end of October.” “Furthermore, cyclical sectors are exhibiting the broadest breadth readings, including financials, which are finally participating in the rally.”
Whether or not market breadth improves and stocks continue to rise is likely to be determined by how the US economy and corporate earnings perform in the coming months.
Many data points continue to point to economic strength in the United States. Consumer spending remains positive, GDP increased by 4.9% in the third quarter, and job growth remains positive.
At the same time, monthly job growth has slowed, the unemployment rate has risen 0.5% from its trough, debt delinquencies are rising but remain historically low, manufacturing activity is contracting, and small business hiring plans have decreased.
For the uninitiated, Hussman has repeatedly made headlines by predicting a 60% drop in the stock market and a decade of negative equity returns. And, even as the stock market has continued to rise, he has maintained his doomsday predictions.
But, before you dismiss Hussman as a wacky perma-bear, take another look at his track record. The following are his arguments:He predicted in March 2000 that tech stocks would fall 83%, and the tech-heavy Nasdaq 100 index fell a “improbably precise” 83% between 2000 and 2002.In 2000, he predicted that the S&P 500 would likely have negative total returns over the next decade, which it did.He predicted that the S&P 500 would fall 40% in April 2007, and it fell 55% in the subsequent crash from 2007 to 2009.Hussman’s recent returns, on the other hand, have been less than stellar. His Strategic Growth Fund has fallen roughly 48% since December 2010, and 9.6% in the last year. In comparison, the S&P 500 has gained about 13% in the last year.Hussman’s bearish evidence continues to pile up, and his calls for a significant sell-off over the last couple of years began to bear fruit in 2022. Yes, there may still be opportunities to profit in this new bull market, but when does the mounting risk of a larger crash become too much to bear?That is a question that investors must answer for themselves — and one that Hussman will continue to investigate in the meantime.
