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John Hussman : Outside the Oval / The Case Against the Fed



November 22, 2010 – Comments (2)

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.


Outside the Oval / The Case Against the Fed
Nov 22, 2010
John P. Hussman, Ph.D.


When we analyze historical relationships between economic and financial variables, it's important to examine the data for "outliers" that significantly depart from typical behavior. Very often, these outliers are corrected over time in a way that creates profit opportunities. In the office, we usually refer to these observations as being "outside the oval," because they diverge from the cluster that describes the majority of the data.

Failing to recognize data that is outside the oval can lead investors to learn dangerous lessons that aren't valid at all. A good example of this is the relationship between valuations and subsequent market returns. The chart below presents the historical relationship between the S&P 500 dividend yield and the actual annual total return achieved by the S&P 500 over the following decade. The majority of the points cluster nicely - higher yields are associated with higher subsequent returns. But there is a clear segment of the data that breaks away from the oval. I should note that the same departure is evident on the basis of P/E ratios that reflect normalized (full cycle) earnings, so this is not simply a dividend story.

Prior to about 1995, the lowest yield ever observed on the S&P 500 was 2.65%, and then only at the three most extreme valuation peaks in history - August 1929, December 1972, and August 1987. But in the mid-1990's, valuations broke free of their prior norms. As the bubble continued and yields fell further, investors observed that poor dividend yields were actually accompanied by high returns over the following decade anyway. By the time the market reached its peak in 2000, the dividend yield on the S&P 500 had declined to just 1.07%, and dividend yields were almost universally discarded as a measure of stock valuation. The intellectual case was seemingly reinforced by the idea that stock repurchases had made dividend yields an obsolete measure of valuation, even though the calculations made by Standard and Poors for both the level and the growth rate of index dividends for the S&P 500 properly reflect the impact of repurchases.

Unfortunately, discarding the information from dividend yields was the wrong lesson. As you can see in the chart, the data points eventually came back into the oval: the extraordinarily low yields observed at the tail of the bubble were followed by a decade of negative total returns, including two separate declines of more than 50% each.

2 Comments – Post Your Own

#1) On November 22, 2010 at 12:02 PM, rfaramir (28.60) wrote:

Oops, he's not so good after all: "I do agree with Krugman that the U.S. could use additional stimulus spending"

No one that agrees with Krugman has their head on straight. Hussman sounds like a very intelligent man, and can probably be treated as a sound ally against the Federal Reserve. He comes across as a patriot defending our representational democracy (which is okay as far as it goes) against the unconstitutional actions of the Fed.

But an Austrian economist he is not, and therefore not a fully trustworthy voice in the economic wilderness. In particular, any stimulus spending is abhorrent to a true free market proponent, as is any interest rate manipulation of the Fed. Interest rates in particular are the signal that all entrepreneurs use to determine if risky investments are worth it, and a distorted core signal produces malinvestments that cause a boom and must result in a bust when the artificial stimulus is withdrawn.

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#2) On December 04, 2010 at 11:09 AM, hhasia (65.14) wrote:

HI Binve


Off topic. Can we see an update of charts for Asia? (HSI) I appreciate it.

China is marching to a different drummer...tightening!!!.


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