John Hussman, the president of the Hussman Investment Trust who called the 2000 and 2008 stock market crashes, is the first to admit that his warnings around high valuations aren’t much use to investors in the near-term.
But it’s hard to argue against the track record of his most preferred valuation measure — total market cap of non-financial stocks to total revenue of those stocks — when it comes to long-term stock-market returns. When the gauge is elevated, long-term future returns have historically been abysmal.
Unfortunately for investors, the measure just hit an all-time high, topping levels seen in 1929, 2000, 2008, and 2022.
Here’s the metric:
Hussman Funds
“Last week, our most reliable measure of stock market valuations hit the highest extreme in history,” Hussman wrote in a July 20 commentary. “It wasn’t because more money was blown into the market like a balloon, or poured into the market like a bathtub with an open spigot. It was because people were willing to exchange record numbers of dollars for the privilege, hope, and excitement of getting shares of stock into their hands.”
As Hussman notes in the quote above, he likes the metric so much because of its ability to forecast future returns with high accuracy. Here’s the relationship between valuation levels and 12-year annualized future returns.
Hussman Funds
While current levels suggest -6% annualized returns over the next 12 years, Hussman said that losses usually come in a larger sell-off that can unfold over the course of a few years. With valuation levels at record highs, the risk of a crash is there, he said.
“As of July 16, 2024, the S&P 500 would have to fall by just over 70% to reach what have historically been run-of-the-mill valuation norms,” he said.
While Hussman’s valuation measure doesn’t necessitate near-term losses, there is some evidence that stocks could soon face downside. Hussman’s metric of “market internals” — basically a broad measure of individual stock performance that effectively acts as a gauge on investor sentiment — is relatively flat. Historically, that has meant downside for stocks, and Hussman regularly refers to periods of high valuations and poor market internals as “trap door” situations.
Hussman Funds
Hussman’s track record — and his views in context
Stocks indeed face uncertainty ahead. As the Federal Reserve moves toward cutting interest rates, the labor market has shown signs of weakening.
The unemployment rate is now at 4.1%, up from recent lows of 3.4%. Year-over-year growth of full-time employees is also in recessionary territory.
Rosenberg Research
Further unraveling of the labor market could send the economy into recession, hurting earnings and stock performance. Fed rate cuts, on the other hand, could help to restimulate economic growth and stave off a downturn.
Despite the uncertainty, Hussman’s warnings for potential downside are very much on the margins of consensus views. He does have company in a few credible names, however, perhaps most notably in GMO cofounder Jeremy Grantham, who has warned repeatedly over the last few years that stocks are in a bubble that’s due to burst.
For the uninitiated, Hussman has repeatedly made headlines by predicting a stock-market decline exceeding 60% and forecasting a full decade of negative equity returns. And as the stock market ground mostly higher, he persisted with his doomsday calls.
But before you dismiss Hussman as a wonky perma-bear, consider again his track record. Here are the arguments he’s laid out:
- He predicted in March 2000 that tech stocks would plunge 83%, then the tech-heavy Nasdaq 100 index lost an “improbably precise” 83% during a period from 2000 to 2002.
- He predicted in 2000 that the S&P 500 would likely see negative total returns over the following decade, which it did.
- He predicted in April 2007 that the S&P 500 could lose 40%, then it lost 55% in the subsequent collapse from 2007 to 2009.
However, Hussman’s recent returns have been less than stellar. His Strategic Growth Fund is down about 55% since December 2010, and has fallen 11% in the last 12 months. The S&P 500, by comparison, is up about 19% over the past year.
The amount of bearish evidence being unearthed by Hussman continues to mount, and his calls over the last couple of years for a substantial sell-off began to prove accurate in 2022. Yes, there may still be returns to be realized in this new bull market, but at what point does the mounting risk of a larger crash become too unbearable?
That’s a question investors will have to answer themselves — and one that Hussman will keep exploring in the interim.