John Hussman: 25% Market Decline if History Repeats Itself

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The latest from John Hussman:

As one of many ways to define “overvalued, overbought, overbullish, rising yield” conditions, consider the points in history when the S&P 500 was at a “Shiller” multiple of over 19 times 10-year inflation-adjusted earnings, the index was at least 8% over its 89-week moving average, within 2% of a 3-year high, with Investors Intelligence sentiment over 45% bulls, less than 30% bears, or both, and with at least one yield measure above its level of 26-weeks earlier (corporate, Treasury bond, or T-bill). This set of conditions produces a cluster restricted to about 8% of market history, and also self-selects for many of the worst times an investor could have chosen to buy stocks, based on the depth of the market’s decline within the following 18 months.

While the criteria above are loose enough to include several false signals, the periods also include late-1961 (-25%), early-1966 (-20%), late-1968 (-30%), late-1972 (-30%, and a nearly -50% loss extending beyond that 18 month window), mid-1987 (-33%), mid-1998 (-12%), mid-1998 (-12% over the next 13 weeks), mid-2000 (-35%, and a loss of more than 50% beyond that 18 month window), and mid-2007 (-55%).

We’d never recommend this as an actual investment strategy, but it’s informative that even if an investor had simply avoided the market for a full 18-month period after every emergence of the foregoing set of conditions (including every false signal, and entirely regardless of what else happened over the next 18 months), that strategy would still have captured cumulative returns about 70% higher than a buy-and-hold since 1963, with periodic losses only about half as deep as a buy-and-hold approach. Again, we’d never recommend this in practice, but it underscores that although the market may move even higher over the near term, investors have achieved nothing durable from investing in overextended conditions like those we presently observe. On average, very weak market outcomes have followed for an extended period of time.


As of last week, the stock market remained characterized by an overvalued, overbought, overbullish, rising-yields syndrome, coupled with an “exhaustion” syndrome that has historically been followed by declines on the order of -25% over the ensuing 6-month period. Our return/risk estimates remain “hard negative” here. We’ve been relatively slow in raising our put option strike prices toward the prevailing level of the market, but I continue to expect some modest “inverse” behavior of Strategic Growth relative to the major indices, largely owing to our lighter holdings of financial stocks, cyclicals, and high-beta stocks here. Though day-to-day movements in individual holdings can affect day-to-day Fund values (as one of our largest and most profitable holdings did last week on a pullback), our stock selections have performed well relative to the indices in recent years, and also since inception. Most of the “basis risk” from weighting our holdings differently from the major indices has tended to be short-lived. Strategic Growth and Strategic International are tightly hedged here.

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