Jim Quinn:
John Hussman has the right to gloat on this Black Monday morning as global stock markets meltdown under the weight of central bank created debt, insane debt financed corporate buybacks, and stock valuations rivaling 1929 and 2000 levels.
He has been scorned, ridiculed and laughed at by the Ivy League educated sociopathic Wall Street titans of greed and avarice. Only in a warped, manipulated, corrupt, rigged financial world would those who speak the truth, use facts, and honestly assess the markets based on historical relationships would a man like John Hussman be abused by the elitist Wall Street lemmings.
He has too much integrity and class to lower himself to the level of Wall Street hucksters. His letter this week is heavy on substance, facts, and sound reasoning. Therefore, it is of no use to CNBC cheerleaders or Wall Street shysters. His lessons are timeless.
Rather, the key lesson to draw from recent market cycles, and those across a century of history, is this:
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, and the most reliable way to measure this is through the uniformity or divergence of market internals. When market internals are uniformly favorable, overvaluation has little effect, and monetary easing can encourage further risk-seeking speculation. Conversely, when deterioration in market internals signals a shift toward risk-aversion among investors, monetary easing has little effect, and overvaluation can suddenly matter with a vengeance.
He wrote this letter over the weekend before the plunge in Chinese shares and the opening decline of 1,110 points on the Dow. There has been no specific event or tragedy which triggered the start of this global equity collapse. Hussman describes the explosion perfectly. The Fed and other central bankers around the world have loaded the wheelbarrow with dynamite (debt) and rolled into the den of rookie Wall Street fire jugglers. The Chinese dropped the torch (currency devaluation) and the world is blowing up like a Chinese sodium cyanide plant.
Last week’s decline, while seemingly significant, was actually a rather run-of-the-mill example of “unpleasant skew” that has regularly followed similar market conditions throughout history.
We should distinguish between causes and triggers here. 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. Likewise, once extreme valuations are established as a result of yield-seeking speculation that is enabled (1997-2000), encouraged (2004-2007), or actively promoted (2010-2014) by the Federal Reserve, an eventual collapse is inevitable. By starving investors of safe return, activist Fed policy has promoted repeated valuation bubbles, and inevitable collapses, in risky assets. On the basis of valuation measures having the strongest correlation with actual subsequent market returns, we fully expect the S&P 500 to decline by 40-55% over the completion of the current market cycle. The only uncertainty has been the triggers.
The U.S. stock market plunged by over 6% in a matter of seconds this morning. The Plunge Protection Team (NY Fed) lept into the breach using derivatives to reverse the plunge. As of midday they had successfully reversed 1,000 points of the 1,110 point plunge. But, please take note of Dr. Hussman’s last sentence in the paragraph above. No matter what happens today, the stock market will decline by 40% to 55% over the next year or so.