Images / Kathy Willens
By multiple measures, US equity valuations are close to
the highest on record.
Investor and former professor John Hussman doesn’t
think this is a sustainable situation, and forecasts that
stocks will see negative returns over a 12-year
Hussman’s perma-bearish views have seen mixed success
in the past, and a good number of Wall Street strategists are
bullish on US stocks through 2018.
As the equity bull market has climbed
into rarefied air, investors have continuously come up with new
ways to rationalize the rally.
Right now, they like to cite earnings growth, which has expanded
for several quarters after a prolonged rough patch. They also
frequently mention interest rates that, despite hawkish signals
from central banks, have remained low, supplying the market with
a seemingly endless supply of cheap money.
On the other side of the spectrum, John Hussman,
the president of the Hussman Investment Trust and a former
economics professor, thinks that the investment community is
unwisely ignoring the most stretched valuations in history on the
heels of a nearly 300% bull market run. Ever the
outspoken bear, Hussman says investors are being willfully
ignorant, which has stocks at risk of a drop that could reach 63%
and send the market spiraling into a full decade of negative
It wouldn’t be the first time in history this has happened.
But Hussman thinks this crash will be different, because the
reasons for market instability are “purely psychological” this
time around, according to a recent blog post.
‘US equity market valuations are at the most offensive
levels in history’
At the root of Hussman’s pessimistic market view are stock
look historically stretched by a handful of measures. According
to his preferred valuation metric — the ratio of non-financial
market cap to corporate gross value-added (Market Cap/GVA) —
stocks are more expensive than they were in 1929 and 2000,
periods that immediately preceded major market selloffs.
“US equity market valuations at the most offensive levels
in history,” he wrote in his November monthly note. “We expect
that more extreme valuations will only be met by more severe
Those losses won’t just include the 63% plunge referenced
above — it’ll also be accompanied by a longer 10 to 12 year
period over which the S&P 500 will fall,
says Hussman. He cites the chart below, which shows how closely
12-year expected returns for the benchmark have historically
tracked Market Cap/GVA, which is shown in inverted fashion. Note
that the expected trajectory for Market Cap/GVA shows the S&P
500 veering into negative territory.
The psychology behind the market’s willingness to accept lofty
stock valuations stems from the flawed rationale
that prices are justified by low interest rates, says Hussman. To
him, the US economy is growing too slowly for
this to be true, and that any belief to the contrary gives people
Investor minds are also being warped by their lengthy and ongoing
experience with rock-bottom interest rates, according to Hussman.
This has fed the belief that only risky assets can generate
desirable returns, and that they should be purchased regardless
“Unfortunately, valuation extremes and speculative moods are
always impermanent,” he wrote. “It’s that failure to distinguish
temporary returns from durable ones that will likely end with
most investors surrendering every bit of return they’ve enjoyed
The life of a perma-bear
It must be noted, however, that Hussman has been sounding the
alarm on a major stock market selloff for years now. Throughout
the second half of 2014, he issued regular warnings about a
crash, even going as far as to say stocks were
crashing in October 2014. The S&P 500 has rallied another
30% since then.
Hussman’s view also stands in stark contrast to many experts
across Wall Street — most notably the equity strategists
responsible for each firm’s S&P 500 forecasts. They forecast
that the benchmark will be little changed from current levels
into year-end, according to data compiled by Bloomberg.
Looking ahead to 2018, UBS sees the S&P
500 climbing as much as 9% over the course of the year.
Meanwhile, Goldman Sachs thinks US stocks will be kept afloat by
speculation and progress around tax reform.
Still, Hussman isn’t alone in the perma-bear camp. He has company
in the form of Societe Generale investment strategist Albert Edwards, who also
sees a stock market crash lurking around the corner.
In a recent note to clients, Edwards identified the
self-described “nightmare scenario”
for what could cause a massive stock blowout. He said that
it could ultimately involve the Federal
Reserve raising rates too slowly, combined with a sharp
uptick in wage inflation.
What’s interesting about the bearish arguments presented by both
Edwards and Hussman is that there’s no firm timetable attached to
either prediction. In fact, Hussman actually acknowledges that
he’s neutral in the near term, because while conditions are ripe
for a crash, people are going to keep buying until the bitter
“It’s enough to be neutral here,” said Hussman. “With that,
further speculation in a wickedly overextended market may not
help us much, but it shouldn’t hurt us much either. In the
meantime, my honest opinion is that Wall Street has gone