Hussman, Gross & Deuteronomy
Board: Macro Economics
For a fire is kindled . . . and shall burn unto the lowest hell, and shall consume the earth with her increase, and set on fire the foundations of the mountains. Deuteronomy 32:22
Yea verily, and that macroeconomic fire is, according to the usual suspects, too much credit – with all the puffy consequences thereof -- paired with blissful ignorance.
Seasons Don’t Fear the Reaper – But Investors Should.
In his current market commentary, which is as usual intelligent and well-argued and should be read in its entirety, John Hussman reiterates his advice that – and I am paraphrasing a bit here – WE ARE ALL DOOMED:
Present market conditions . . . represent a syndrome of overvalued, overbought, overbullish, rising yield conditions that has emerged near the most significant market peaks – and preceded the most severe market declines – in history . . . . Pursuing short-term returns in those environments would have been a mistake, because the initial losses typically came in the form of vertical “air pockets. . . .”
Investors underestimate the risk:
. . . investors unanimously point to the Fed, believing that it will be safe to hold stocks until the instant some signal occurs that inflation is picking up or the Fed is stepping back, and assuming that tens of millions of investors can simultaneously exit stocks at that point, into what would surely be a vacuum of demand.
The situation is like . . . well, it is like one of the worst analogies in the history of commentary:
This is like standing by a window at a party, seeing an oncoming wrecking ball, and reasoning that the prevailing wind will slow the ball down long enough to eat another cupcake and still beat the crowd down the stairs the moment the glass breaks.
Wow! This raises so many questions . . . .
“Eat another cupcake?” Just what kind of parties do economists have, exactly?
And who has a party upstairs?
Not to mention, what leads one to think that the way to explain the idea of a crowded trade to the common man is to liken it to a wrecking ball ruining an upstairs cupcake party? And who thinks that the prevailing wind would slow down a wrecking ball?
I am not sure that Dr. Hussman has a very clear understanding of the common investor.
For example, let us suppose, just for the sake of argument, that a bunch of West Virginia guys are having a party, and one of them – call him Hildy – looks out the window and sees a wrecking ball heading his way. Here is how it would play out in real life:
Hildy: Hey guys, there is a wrecking ball heading toward the window!
Hildy: There is a wrecking ball heading toward the window!
Bob: Is it Mike Milligan and his steam shovel?
Hildy: No really, look . . .
Jimmy: Whatcha drinking there, Hildy? I think I’ll have some myself!
Hildy: Gee, it sure looks real . . .
Jesse: Here’s to Hildy!!
Hildy: But . . .
Howie: Here, Hildy, catch! [tossing Hildy a Stroh’s long-neck]
Hildy: Thanks, man!
I was going to provide an even worse analogy, just for fun, but I could not come up with one. So, back to Dr. Hussman:
. . . present valuations are consistent with near-zero total returns on the S&P 500 over the coming 5-year period.
To be fair, Dr. Hussman then provides a series of thoughts going through an investor’s mind over time that is really quite good – much better than the cupcake/wrecking ball story. Please go to the original article to read it.
. . . “what I worry about most is that conservative investors will become impatient with maintaining a defensive position in a dangerous and elevated market - not because investment prospects have materially improved, but simply because short-lived runs of speculative relief seem too enticing to miss.” This is exactly what I see happening.
I doubt that investors who are late to exit this party – when everyone on Planet Earth appears to have the identical exit criteria – will be able to successfully walk away at all. . . . I would strongly encourage investors to allow for the possibility of the stock market losing something on the order of 40% of its value over the completion of the present market cycle.
One of Jovial John Hussman’s acolytes, William “Hurricane” Hester, has recently made a well-researched and somewhat convincing argument that investors in search of international diversification should eschew the standard broad international index-based strategy in favor or a more country-specific strategy. Here are a couple of excerpts, but please read the entire article:
Diversification into international equity markets by US investors has relied on one constant benefit: better portfolio risk attributes. . . . These risk attributes were the result of low correlations and low betas between broad global benchmarks and the US markets.
. . . the beta of international benchmarks relative to the US has been rising . . . . For investors seeking out the proverbial free lunch of international equity diversification – like returns with lower risk – this doesn’t sound like a favorable shift in trends. And it’s not . . . . Over the last couple of years . . . [t]he portfolio risk of a diversified equity portfolio has been higher than a US domestic-focused portfolio.
How should investor’s respond to the changing landscape of international investing? One solution would be to wait out the recent trends in the data . . . .That may be too risky a strategy. . . a more promising solution may be to begin to think about the investment potential and diversification characteristics of individual countries . . . gaining international exposure not through broad benchmarks, but instead through a subset of countries based on individual characteristics.
The Credit Tsunami/Avalanche/Supernova.
In his most recent Investment Outlook, Bill Gross warns of impending trouble and provides fairly concrete investing advice. The article should be read in full, both for context and for more detail. Here are a few excerpts:
Each additional dollar of credit seems to create less and less heat. In the 1980s, it took four dollars of new credit to generate $1 of real GDP. Over the last decade, it has taken $10, and since 2006, $20 to produce the same result. . . . 2% real growth now instead of an historical 3.5% over the past 50 years; likely even less as the future unfolds.
. . . today’s near zero bound interest rates cripple savers and business models previously constructed on the basis of positive real yields and wider margins for loans. Net interest margins at banks compress; liabilities at insurance companies threaten their levered equity; and underfunded pension plans require greater contributions . . .
So our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic – it is running out of energy and time. . . . The countdown begins when investable assets pose too much risk for too little return . . . .
What should investors do in the face of this grim future? Mr. Gross suggests the following (with more details available in the original article):
(1) Position for eventual inflation . . . .
(2) Get used to slower real growth . . . .
(3) Invest in global equities with stable cash flows . . . .
(4) Transition from financial to real assets if possible at the margin . . . .
(5) Be cognizant of property rights and confiscatory policies in all governments . . . ..
What do I recommend? Honestly, I cannot see why anyone would care! But for the record I recommend eating wild-caught fish at least five times a week, reading Nero Wolfe novels, and sitting outside late at night every now and then and contemplating the nature of things.
Oh, and on the investing front, do not stretch for yield; boost your balance sheet through frugality rather than risk.
A Drumlin Daisy