In the context of historical evidence and outcomes, present market conditions give us no choice but to remain highly defensive. Valuations remain rich on the basis of normalized earnings (which are better correlated with subsequent returns than numerous popular alternatives based on forward operating earnings, the Fed Model and the like). Investor sentiment is overcrowded on the bullish side even as corporate insiders are liquidating at a rate of eight shares sold for every share purchased – a surge that Investors Intelligence describes as a “panic.” Market conditions remain steeply overbought on an intermediate and long-term basis, with the S&P 500 still near its upper Bollinger bands (two standard deviations above the 20-period moving average) on weekly and monthly resolutions. We continue to observe wide divergences in market action, from century-old criteria such as the weakness in transports versus industrials (which suggests an unwanted buildup of inventories) to more subtle divergences and signs of exhaustion in market internals.
Overall, we continue to estimate a steeply negative return/risk for stocks on horizons from 2-weeks to 18 months. I recognize that this is easy to treat as disposable news, given that the ensemble methods we developed to capture both post-war and Depression-era data have indicated a negative return/risk profile for stocks since April 2010, yet the S&P 500 is 18% higher today than it was at that time. Central bank interventions have certainly played a role in that gain. But then, our prospective return/risk estimates have been in the lowest 1% of historical data only since March, and the market loss that would erase the intervening gain since April 2010 is one that we would consider small from the perspective of present market conditions. The average cyclical bear market has historically wiped out more than half of the preceding bull market advance, and stocks have typically surrendered closer to 80% of their preceding bull market gains when the cyclical bear is part of a “secular” bear period such as the one we’ve experienced since 2000 (see the discussion of cyclical and secular fluctuations in A False Sense of Security). I remain convinced that we will observe numerous points in the market cycle ahead where the evidence will support a significant and even aggressive exposure to market fluctuations. Now is not one of those points.
While our estimates of prospective return/risk in stocks remain among the most negative instances we’ve observed in a century of market history, it is important to note that these estimates are largely independent of our conviction that the U.S. economy has already entered a recession. They are also independent of our concerns about instability in the European banking system. With regard to Europe’s banking strains, the capital needs of Spanish banks were estimated at modest levels last week only due to the heroic assumption that distressed banks would be able to massively deleverage their balance sheets without amplifying their losses – an assumption that ZeroHedge refers to as deus ex-fudge while begging the question “just who will these banks sell said debt to?”
Overall, we continue to estimate a steeply negative return/risk for stocks on horizons from 2-weeks to 18 months. I recognize that this is easy to treat as disposable news, given that the ensemble methods we developed to capture both post-war and Depression-era data have indicated a negative return/risk profile for stocks since April 2010, yet the S&P 500 is 18% higher today than it was at that time. Central bank interventions have certainly played a role in that gain. But then, our prospective return/risk estimates have been in the lowest 1% of historical data only since March, and the market loss that would erase the intervening gain since April 2010 is one that we would consider small from the perspective of present market conditions. The average cyclical bear market has historically wiped out more than half of the preceding bull market advance, and stocks have typically surrendered closer to 80% of their preceding bull market gains when the cyclical bear is part of a “secular” bear period such as the one we’ve experienced since 2000 (see the discussion of cyclical and secular fluctuations in A False Sense of Security). I remain convinced that we will observe numerous points in the market cycle ahead where the evidence will support a significant and even aggressive exposure to market fluctuations. Now is not one of those points.
While our estimates of prospective return/risk in stocks remain among the most negative instances we’ve observed in a century of market history, it is important to note that these estimates are largely independent of our conviction that the U.S. economy has already entered a recession. They are also independent of our concerns about instability in the European banking system. With regard to Europe’s banking strains, the capital needs of Spanish banks were estimated at modest levels last week only due to the heroic assumption that distressed banks would be able to massively deleverage their balance sheets without amplifying their losses – an assumption that ZeroHedge refers to as deus ex-fudge while begging the question “just who will these banks sell said debt to?”
by John P. Hussman, PhD., Hussman Funds | Read more:
