John Hussman: Long-Term Investors Should Be Disturbed by This Market's Rich Valuations

by: John Hussman July 16, 2007 | about stocks: IVV / SPY    
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Excerpt from fund manager John Hussman's weekly essay on the U.S. market:

The following chart... projects the potential growth rate of earnings by amortizing the difference between current earnings and the well-defined historical trendline that connects S&P 500 earnings from peak-to-peak across market cycles. This approach has been quite reliable over 7-year horizons (except for those 7-year periods that ended in the late 1990's market bubble). At present, the likely 7-year total return on the S&P 500 is in the low single digits.

7yr return projections 16 07 2007

As I've frequently noted, it's not useful to attempt to forecast specific short-term market outcomes, but valuations have an enormous and reliable impact on long-term outcomes. Investors ignore evidence like this at their peril.

It is also useful to emphasize that the defensive case does not require any expectation that earnings will fall short in the months ahead, or even that profit margins will contract over the coming quarters. If you look at the historical data, it is clear that the correlation between year-over-year earnings growth and year-over-year market performance is zero anyway. The argument is that even on the basis of current earnings -– record profit margins and all –- the market is very richly priced. On the basis of normalized profit margins, the situation is even worse. But we do not need to argue that earnings will decline or disappoint. The potential for margins to erode certainly strengthens the case, but is not the basis of our defensiveness...

Investment professionals that hold themselves out on CNBC as "long-term investors" should be troubled by the paltry long-term returns currently priced into stocks, as well as the historical tendency toward abrupt short- and intermediate-term losses given current conditions. Otherwise any talk of being a “long-term investor” is nothing but lip service.

No, multiples are not as bad as they were in the late 1990's, but those valuations have also been followed by market returns below Treasury bill yields for eight years, and even those meager returns have been achieved only because the market has returned to high valuations currently. If the late 1990's now represent our standard of appropriate valuation, we may as well bury our savings in a bottle in the back yard, because the outcomes will be similar. When even modest future investment returns rely on profit margins and valuation multiples remaining at elevated levels indefinitely, there is no margin for error, and one is no longer investing.

John Hussman

John Hussman

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This article has 9 comments:

  •  
    Jul 16 11:26 AM
    Here's a chart that compares Hussman's Strategic Growth fund to the SPY.

    stockcharts.com/h-sc/u...;p=D&yr=8&...

    Here's a chart for Hussman's Total Return fund, compared to the SPY.

    stockcharts.com/h-sc/u...;p=D&yr=8&...

    With FIVE CONSECUTIVE YEARS of underperformance, should we be listening to John?
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  •  
    Jul 16 12:58 PM
    Here's a chart that compares Hussman's Strategic Growth fund to the SPY, inception-to-date.

    hussmanfunds.com/pdf/h...

    Here's a chart for Hussman's Total Return Fund, compared to AGG, which is a more appropriate fixed-income benchmark.

    hussmanfunds.com/pdf/h...

    ITD returns vs. SPY and AGG are 11.66% vs. 2.08% and 6.49% vs. 3.91%, respectively.

    The difference is that these charts also include 2000, 2001, and 2002, over the course of which HSGFX gained 52% and the S&P 500 lost 38%. He also outperformed the SPY in 2005, despite being hedged much of the time. In my opinion HSGFX is the best risk-adjusted fund available, but it's true he is going to lag permanently if the stock market never corrects again.
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  •  
    Jul 16 01:45 PM
    Gem, click on the links I provided before you start typing. They clearly went from inception to today, including 2000. You ASS U ME d they didn't, you know.

    You might try reading his prospectus while you're at it. He supposedly has his fund designed to outperform in bull markets, which it clearly hasn't.

    If you want a bear fund, may I suggest BEARX?
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  •  
    Jul 16 02:43 PM
    I did click the links - they only go back to middle of 2004 for me. I'm guessing it's because I'm not a member at StockCharts? Since you meant to show his whole record, I apologize for implying you didn't, but in that case I don't know what you're on about - he's up 9-10% a year on the S&P with much less risk (than the S&P or Prudent Bear), and his fund is designed to outperform over the full cycle, not the bull market. Maybe he's wrong, but it's because his arguments are wrong this time, despite being the same ones leading to past outperformance.
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  •  
    Jul 16 03:17 PM
    Maybe it's a stockchart thing, the 3-year limitation. If I can figure out how to upload images here ... or maybe at my blog I'll post it ...
    Reply | Link to Comment
  •  
    Jul 16 07:55 PM
    It's only meaningful to compare HSGFX with SPY over a full market cycle.
    Reply | Link to Comment
  •  
    Jul 16 12:44 PM
    Hum. the main factor that Hussman is misplacing is the weaker dollar and inflationary spiral.
    And these multinationals are benefiting from both.
    Reply | Link to Comment
  •  
    Jul 16 02:26 PM
    The market may be overvalued. But notice he hasn't said this is a top.

    This is interesting information but it is hardly actionable, so what value does it have?
    Reply | Link to Comment
  •  
    Jul 17 04:18 PM
    Valuation analysis can never pick a market top or bottom, because the market always overshoots. I agree that you need to judge Hussman -- and also Jeremy Grantham -- on their performance over the entire cycle, because they are always early due to the overshoot but end up with market beating performance due to their sensitivity to valuation and refusal to get caught up in crowd psychology.
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