John Hussman is not a popular person among stock marketbulls. And he won’t be getting any warm love from bulls with his latest blog post. Hussman says the S&P 500 (INDEXSP:.INX) is likely to be lower in a decade from now, as he looks across the span of stock market value relative to projected Gross Domestic Product.
Hussman is singing from the same hymnbook that many hedge fund insiders subscribe to, only his reasoning, the song he’s singing, is slightly different from those of some quantitative trading managers with whom ValueWalk has spoken.
John Hussman on future GDP value
Hussman projects future GDP value, the purported measure of a nation’s economic output, to determine his estimation of the future value of equity markets. While quantitatively orientated risk managers might take apart the impact withdrawal of stimulus on bond prices, government debt on the money supply or the loosing grip the US has on the world reserve currency of choice, Hussman looks at raw valuations and says “even under optimistic assumptions” stock market returns are going to turn negative over the next decade.
Hussman points out the ratio of stock market capitalization of the market in 2000 – and makes comparisons today’s market. And that look, much to the chagrin of bulls, isn’t pretty. In fact it’s a touch grotesque.
Hussman conducts a calculation that considers the stock market capitalization, its core value, relative to GDP. The formula is reasonably complex and involves the S&P’s 10 year annual returns. What is grotesque is when he compares pre-crash 2000 to what is considered pre-crash 2014 in terms of returns as a percentage of market capitalization relative to GDP growth. He makes the following observations:
(1.063)(0.63/1.54)^(1/10) – 1.0 + .011 = –1.7% annually
(1.063)(0.63/1.34)^(1/10) – 1.0 + .020 = 0.5% annually
In other words, in 2000 a value investor looking into one ten year projection of GDP might expect to see a negative returns picture. Not that much materially different than the current environment.
Low interest rates justify higher valuations
This is not a good value picture, and Hussman considers the excuses for high valuations he continues to see “parroted,” as he says, across the bull landscape. “Lower interest rates justify higher valuations,” is a common theme among bullish talking heads. Hussman debunks this by considering that even if value analysts are accurate and interest rates will stay near zero – considered a lower probability outcome in some quantitative models – the value is still questionable.
“If we assume that short-term interest rates will remain at zero for another 3-4 years instead of a more normal 4%, one can justify stock valuations 12-16% above where they otherwise might be,” he wrote. “That 12-16% elevation would in turn shave about 4% annually from equity returns over that same 3-4 year period. Unfortunately, the most reliable valuation measures we identify are more than double pre-bubble historical norms, so the “justified valuation” argument is exactly the sort of twisted statement that Graham warned about.”
Using logic from a value investor’s all time classic book, Security Analysis, written in 1934 by Benjamin Graham & David L. Dodd and considered relevant among certain value investors today, Hussman gets even more granular in this projections. He predicts returns will be negative on the S&P 500 for the next eight years. This implies a stock market implosion date of 2014, among the early inside projections I’ve seen although he is not alone. Hopefully the U.S. Federal Reserve has the derivatives time bomb under control by the next implosion date if that’s true.
Read the full report here.