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Expert warns of negative returns for next decade
August 20, 2022
Investors are divided on whether or not there will be a linchpin of the Fed moving towards moderate policy.
According to John Hussman, this is not the case, and the environment for a continuous increase in supplies is bad.
The Fed has said it plans to continue its aggressive policy until inflation falls significantly.
The Federal Reserve has sent home a message in recent weeks: it is not done to tighten monetary policy.
Some of the investors don’t seem to believe them and are anticipating a shift in the central bank’s approach in the coming months, with inflation appearing to be coming down. This mindset has contributed to the S&P 500’s 17% rally since mid-June.
But this bet against the Fed’s stated intentions is a mistake, according to John Hussman, the president of the Hussman Investment Trust — an old bear who mentioned the stock markets’ demise in 2000 and 2008.
Just look at the Fed’s decision-making history, he says.
“Wall Street seems confident that the half-point drop from the highest core inflation rate in 40 years, currently 5.9%, will encourage the Fed to ‘turn around’ to cut rates in no time,” Hussman said. in a commentary on Monday. “But when the Federal Funds rate was below core inflation, with core inflation even exceeding 2.5%, the Fed never easing unless the recession pushed the unemployment rate to 6% or higher.”
The chart below shows two leading indicators for the real fed funds rate. One is an extension of the Taylor Rule, a formula that derives a fed funds rate depending on current inflation and economic growth. The other is a fed funds rate calculated using non-monetary variables. As the chart indicates, both have historically been closely correlated with the actual fed funds rate. And given the current gap, Hussman believes the Fed is catching up on further hikes.
The slim chance that the Fed will adopt a moderate policy is likely bad news for equities, Hussman stressed.
It’s also worth noting that the only bear market low in history that occurred in the middle of a Fed tightening cycle was in 1987, with an S&P 500 forward operating P/E of less than 10, and a price/yield multiple of less. than a quarter of today’s level,” he said.
Stock valuations still well above historical norms also bode ill for stocks, as does the amount of risk-averse sentiment still in the market, Hussman said.
The median price-to-reward ratio of the S&P 500 (green) and the price-to-reward ratio of the top (purple) and bottom (red) 10% of the index are all close to or above their dotcom bubble levels, according to Hussman’s chart below.
While Hussman isn’t specifically advocating a near-term crash, he said the outlook for long-term returns is bleak. Over the next 12 years, he expects the market to return -2.9% annually.
To make this decision, the valuation metric that Hussman uses is the ratio of the market capitalization of non-financial stocks to the total income of non-financial stocks. He calls it the most reliable valuation measure in terms of predicting long-term returns.
Hussman’s track record – and his views in context
Whether or not the Fed will soon return to a moderate policy is one of the biggest questions on Wall Street right now.
A camp says yes. For example, Preston Caldwell, the head of Morningstar’s US economics team, sees the Fed raise the Fed Funds rate to 3% this year (50 basis points above current levels) before cutting the rate to 1.75 in 2023. %. inflation will drop significantly and economic growth will slow down in the meantime.
Another camp, including Rick Rieder, CIO of BlackRock’s Global Fixed Income, says no. Rieder believes the Fed will raise the Fed Funds rate to 3.5% and then pause.
“The Fed can’t fight inflation and then ease and ease,” Rieder told Insider on Wednesday. “I think this ‘pivot’, the market’s assumption that they’ve flipped and that they’ll start easing next year, isn’t supported by actual data.”
As far as appraisals go, Hussman has company in his criticism of their expansion. Mike Wilson, Morgan Stanley’s chief US Equity Strategist, said in a note to clients Monday that valuations are particularly high given the collapse in corporate earnings he envisions as a result of the tightening policy.
Savita Subramanian, head of U.S. equity and quantitative strategy at the Bank of America, also said in late 2021 that the index would deliver negative returns over the next decade, excluding dividends, and emphasized the 80% explanatory power that valuations have when it comes to returns. decade out.
Markets remain in a critical stalemate as investors and policymakers wait to see how sticky inflation numbers develop. Economic indicators will also be closely watched for signs of significant weakness in the economy. At the moment, the labor market remains exceptionally strong, but manufacturing activity is starting to slow down and corporate sentiment is declining. Housing market activity is also slowing dramatically.
For the uninitiated, Hussman has repeatedly made headlines by predicting a stock market dip of more than 60% and forecasting a full decade of negative stock returns. And as the stock market had continued to run higher for the most part, he continued his doomsday scenarios.
But before you dismiss Hussman as a shaky perma bear, consider his track record again. These are the arguments he set forth:
He predicted in March 2000 that tech stocks would plunge 83%, after which the tech-heavy Nasdaq 100 index lost an “implausibly accurate” 83% over a period from 2000 to 2002.
Predicted in 2000 that the S&P 500 would likely see negative total returns over the next decade, which it did.
Predicted in April 2007 that the S&P 500 could lose 40%, but lost 55% in its subsequent collapse from 2007 to 2009.
However, Hussman’s recent returns have been less than great. Its Strategic Growth Fund has fallen 47% since December 2010, although it has risen just under 1% in the past 12 months. By comparison, the S&P 500 is down 2.8% over the past year.
The amount of bearish evidence unearthed by Hussman continues to increase. Sure, returns can still be made in this market cycle, but when does the mounting risk of a bigger crash become too unbearable?
That’s a question investors will have to answer for themselves — and one that Hussman will clearly continue to explore in the meantime.