A prominent Wall Street skeptic who accurately predicted the bursting of the tech bubble and the 2008 financial crisis is sounding the alarm bells once again. John Hussman, president of Hussman Investment Trust, believes current market conditions point to the risk of an impending stock market crash or “air pocket” that could send the S&P 500 plummeting by 50% to 70% from current levels.
In a recent investor note, Hussman laid out the red flags that have him bracing for turbulence. Chief among his concerns are sky-high stock valuations that he says are rivaling the peaks of 1929 and early 2021 based on his preferred valuation metric – the ratio of non-financial market capitalization to gross value added.
“These levels indicate the S&P 500 is likely to return around negative 5% annualized over the next 12 years, according to Hussman’s math,” the note stated. “Other classic measures like the Shiller CAPE ratio are also alarmingly elevated.”
Hussman argues that such nosebleed valuations alone would be worrisome enough for long-term investors given their strong inverse correlation with future market returns over a 10-12 year timeframe. But he believes several other technical and sentiment indicators create heightened short-term crash risk as well.
A Secret Sauce for Detecting Froth
One such indicator is Hussman’s own “market internals” gauge that has served as his proverbial magic 8-ball for detecting psychological froth and investor mania since its creation in 1998. By analyzing the performance dispersion across thousands of securities, the indicator aims to gauge the uniformity or ubiquity of bullish psychology in the market.
“The gauge is relatively flat,” Hussman observed, pointing to the ominous signal given its historical correlation with serious market drawdowns whenever extended bouts of flatness have occurred, as was the case prior to the 25% peak-to-trough decline in 2022.
The investing veteran also flagged various measures of “overextended conditions” flashing yellow based on factors like the S&P 500’s sharp divergence above its 40-day moving average despite deteriorating market internals and breadth. He views such breakouts amid unfavorable conditions as a symptom of the intense speculative fervor currently gripping markets.
“Nothing in our discipline relies on a forecast, a collapse, or even a retreat to historically normal valuations,” Hussman cautioned. “But we do take prevailing conditions seriously.”
A Doomsday Call to Be Reckoned With
Hussman’s dire prognosis echoes the superbubble warnings issued over the past couple of years by fellow market eminence Jeremy Grantham, co-founder of GMO. Like Hussman, Grantham built his fearsome reputation by raising the red flag ahead of the previous two market cycles’ most apocalyptic moments in 2000 and 2008.
Speaking at a recent investment conference, Grantham pointed to the statistically extreme levels of the Shiller P/E ratio and other valuation measures as the clearest indicator that the gravity-defying bull market since the pandemic lows has taken on truly bubbly characteristics.
“There has never been a sustained bull market starting from a Shiller price-to-earnings ratio of 33 — it’s in the top 2% of the historical range,” Grantham declared. “If you want to have a long, impressive rally, you want to see profit margins down, unemployment up, and P/Es low.”
David Rosenberg and Gary Shilling, two other former high-profile Wall Street economists, have similarly pounded the table over irrational stock market exuberance versus deteriorating economic fundamentals.
A Clash of Clashing Viewpoints
Of course, such dire predictions from the perma-bear pundits clash with the constructive outlook embraced by most mainstream market strategists. The majority of Wall Street remains sanguine about further upside for stocks given the surprising resilience of the U.S. economy and encouraging inflation data that should allow the Federal Reserve to pause and even reverse course on interest rate hikes later this year.
But for the likes of Hussman, Grantham & Co., the steady drip-drip-drip of mounting evidence – obscene valuations, unfavorable market internals, technical overextension, and excessive speculative sentiment – has simply become too deafening to ignore as visions of a subsequent vertical price collapse dance in their heads.
Hussman is well aware his clarion call for a market reset of cataclysmic proportions could be ridiculed once again if stocks simply grind higher in the months ahead. But he insists his role isn’t to forecast precise market turning points, but rather to soberly weigh the evidence signaling when risk/reward dynamics have deteriorated to levels that warrant maximum defensive positioning.
A Track Record That Demands Respect
And for those tempted to tune out Hussman’s alarm as just more noise from the usual cadre of permabears, a deeper look at his track record commands respect:
- In March 2000, he predicted tech stocks could plunge 83% mere days before the Nasdaq 100 embarked on an “improbably precise” 83% crash over the next two years.
- That same year, he called for a full decade of negative equity returns for the S&P 500, which ultimately materialized.
- Then in April 2007, he forecasted a potential 40% decline in the S&P 500 just months before it actually plunged 55% amid the subprime mortgage implosion from October 2007 to March 2009.
So while Hussman’s recent performance has been lackluster, with his Strategic Growth fund down 51% since late 2010 versus a 33% gain for the S&P over the past year, his historical perspicacity around major inflection points is tough to ignore.
The million dollar question is whether the mounting bearish signposts flagged by Hussman and his ilk will ultimately prove more prescient than the economic green shoots currently fueling Wall Street’s optimism. Investors would be wise to weigh both sides of the debate, as the stakes get higher with each breath the aging bull market takes.
