Judging The Future At A Speculative Peak – John Hussman

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Judging the Future at a Speculative Peak

John P. Hussman, Ph.D.
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“I know of no way of judging the future but by the past.” – Patrick Henry

With valuations still extreme and deterioration in market action continuing to indicate a shift toward risk-aversion among investors, we are less concerned about specific factors such as Greece than about much more general pressures that threaten to force an upward spike in compressed risk-premiums. We’ve often noted that a market collapse is nothing other than that phenomenon: razor-thin risk premiums that are then pressed abruptly to higher levels. Undoubtedly, any worsening of Greek credit strains could contribute to the timing of such a spike. But until we observe a firming of market internals coupled with a fresh narrowing of credit spreads, it’s important to recognize that downside risks are much more general, and not are confined to any particular news item.

A rather classic feature of speculative peaks is the eagerness of speculative companies to issue equities to the public while the getting is good. On that front, fully 78% of the initial public offerings over the past 6 months are companies that have negative earnings; a percentage that eclipses both the previous record of 76% at the height of the tech bubble in 2000, as well as the second-highest extreme of 65%, which was set, not surprisingly, in April 2007 during the distribution phase that preceded the 2007-2009 market collapse. Likewise, private equity firms have been dumping their ownership stakes at a record pace.

Of course, in equilibrium, somebody has to buy these same shares, and so one has to ask – who was heavily accumulating stock at the very peaks of the equity bubbles of 2000, 2007 and at present? Unfortunately, some of the most aggressive buyers at equity market peaks have been corporations themselves, via debt-financed stock repurchases. In recent weeks, the pace of these repurchases has eclipsed the previous peak that was set (again not surprisingly) at the 2007 market extreme. What’s rather disturbing is how seemingly resistant investors are to an examination of how these episodes have repeatedly ended.

Among the frequent remarks on financial television that make us wince here is the idea that because rich market valuations, heavy issuance of speculative IPOs, Greek debt concerns, private-equity divestitures and other factors have been openly discussed, these risks must also be fully discounted in the market. The theory seems to be that once a risk is widely known, it is no longer a risk. Even the most cursory review of the last two bubbles should disabuse investors of that idea. One might, for example, refer to the February 11, 2008 issue of Business Week, well before the market collapsed in earnest, which showed a bright red graphic of a melting house, with the headline “Meltdown – For housing, the worst is yet to come.” That cover appeared a few weeks after Newsweek ran a cover titled “Road to recession.” Both concerns would be realized over the following year as the worst economic collapse since the Great Depression.


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