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John Hussman: Extend and Pretend



April 12, 2010 – Comments (5)

John Hussman of puts out a Weekly Market Comment (which I highly encourage you to read every week). Per usual, this is another good article.


Extend and Pretend
John P. Hussman, Ph.D.
April 12, 2010


Over the past 12 years or so, I've been repeatedly astonished at the tendency of investors to do things that they should have known to avoid simply with the use of a calculator and basic arithmetic. We've used numerous metrics during this period to show that the estimation of long-term market returns (7-10 years and beyond) doesn't require calculus or statistics, but fairly direct methods to normalize earnings, plus a bit of arithmetic. Rich valuations are predictably followed by sub-par returns. As a result, investors have earned an average annual total return of just 2.4% in the S&P 500 over the past 12 years, while enduring two separate instances where they have lost about half of their money as part of the ride. Essentially, we have gone nowhere in an interesting way. At present, investors have priced the market at a level that makes a continuation of this experience likely for several years to come.

I noted last week that at current valuations, the S&P 500 is priced to deliver a total return of only about 5.7% annually over the coming decade. Though it generally takes about 7-10 years to reliably revert from valuation extremes, a good portion of that reversion often occurs within 5 years (outside of the twin bubbles to the 2000 and 2007 highs). Presently, a normalization of valuations, not to extreme undervaluation but simply a reversion to post-war, non-bubble norms, would imply an average annual return for the S&P 500 of just 2.97% over the coming 5 year period.

This outcome is not dependent on whether or not we observe a second set of credit strains, but is instead baked into the cake as a predictable result of prevailing valuations. The risk of further credit strains simply adds an additional layer of concern here. Investors have chased risky securities over the past year to the point where the risk premium for default risk has eroded to the levels we saw at the peak of the credit bubble in 2007. My sense is that this is a mistake that will be painfully corrected. Investors now rely on a sustained economic recovery and the absence of any additional credit strains - and even then would be likely to achieve only tepid long-term returns from these levels.

5 Comments – Post Your Own

#1) On April 13, 2010 at 12:40 PM, outoffocus (24.00) wrote:

Great article.  Right now I'm only 50% invested and I'm wondering should I stay conservative (in anticipation of a crash) or continue to invest until I'm out of cash. This article has me leaning toward the conservative approach.

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#2) On April 13, 2010 at 1:04 PM, binve (< 20) wrote:


Yep, when Hussman speaks it is worth listening. He is one of the few econmists who not only doesn't have his head up his ass, but makes excellent points and logical analysis.

His work is very statistically based, and the stats say the risk vs. reward here *stinks*!


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#3) On April 13, 2010 at 2:29 PM, vriguy (71.90) wrote:

The problem with stat based approaches is they are based on historical data and we have only one sample of history. Statistical methods have wonderful predictive ability when dealing with reproducible probabilistic events like multiple coin flips.  The stock market, unfortunately, follows its own unpredictable course.  Hussman is a shrewd man who's proven his smarts.  Listen to him, but remain skeptical - he could be very well be right, or woefully wrong.

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#4) On April 13, 2010 at 2:42 PM, binve (< 20) wrote:


Hey vriguy,

>>he could be very well be right, or woefully wrong

That is one way to look at it, but it's not the way I look at it.

Being "right" or being "wrong" had nothing to do with anything: Hussman, me, you, [some random celebrity that would make this statement funny]. Because being "right/wrong" is luck.

I am far more interested in playing risk/reward. Given a similar scenario based on >100 years of stock market history, what is the likelihood that the market will rally another 50% from these levels? You have to weigh the stats based on historical data. Then you have to weight the stats based on the macroeconmics (sustainability of the recovery, monetary policy, debt issues, etc.).

Assign risk, assign reward and deploy capital accordingly. If a move or new data invalidates your assumptions, then change your position.

Being right has nothing to do with it. Managing risk has *everything* to do with it.

My $0.02 of course :)..

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#5) On April 13, 2010 at 3:02 PM, AvianFlu (< 20) wrote:

In my view, corporate earnings have not been a disaster due to the plant closings and mass layoffs. Businesses have been generally good at reducing their costs. However, this formula can't work indefinitely. At some point they will need to increase revenues. Also, as more of their earnings are taken away in taxes there will be less left over for the shareholders. Given the run up in stock prices  that has already occurred, the prognosis going forward doesn't appear very rosy. Bonds and treasuries also appear very risky. This is not a great time to be an investor, but opportunities do exist....somewhere. Probably in other countries at this point.

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