This Time Is Different,; But The Ending Will Be The Same

Tyler Durden's picture

Via John Hussman's Weekly Market Comment,

There is one critical feature of the market advance of recent years that differs from prior bull market advances, and while it’s related to quantitative easing, the distinction is not quite as simple as that. In the market advances that culminated in the 1929, 1972, 1987, 2000 and 2007 pre-crash peaks, a combined syndrome of overvalued, overbought, overbullish conditions emerged in each instance. These syndromes can be defined in numerous and largely overlapping ways (see our October 2007 comment Warning: Examine All Risk Exposures for an example), but in general, once these syndromes appeared, steep market losses typically followed in fairly short order. In instances where they didn’t, the syndrome was usually a one-off outlier driven by a short spike in bullishness. Still, in no case did one observe repeated, increasingly severe overvalued, overbought, overbullish syndromes persisting entirely uncorrected and without consequence.

The fact that there have been no historical exceptions to this pattern prior to the recent half-cycle has posed quite a challenge for us in recent years. As I detailed in Formula for Market Extremes, it forced us to adapt by imposing restrictions (based on factors such as market action across a range of risk-sensitive instruments) to mute our defensiveness even in conditions where historically-informed measures of prospective market return/risk are blazing red. We don’t get to re-live the recent cycle in a way that shows the effectiveness of any of that, but I expect it to be evident enough over the completion of the present cycle and the ones that follow, even in the event quantitative easing becomes a more frequent policy (though the unwinding challenges appear likely to make the whole episode regrettable).

The Federal Reserve’s policy of quantitative easing has produced a historically prolonged period of speculative yield-seeking by investors starved for safe return. The problem with simply concluding that quantitative easing can do this forever is that even speculative assets have to compete with zero. When a safe zero return is above the medium or long-term return that one can estimate for a very risky asset, the rationale for continuing to hold the risky asset becomes purely dependent on expectations of immediate short-term price gains. If speculative momentum starts to break, participants often try to get out the door simultaneously – especially if there is some material event that increases general aversion to risk. That’s the dynamic that produces market crashes.

I’m not saying a market crash is imminent, but it is a risk because very reliable valuation methods (that have remained reliable even in the recurring bubbles since the late-1990’s) presently estimate negative prospective nominal total returns for the S&P 500 on every horizon of 7 years or less, and an annual total return of about 1.9% over the coming decade. On the other hand, these same methods projected negative 10-year prospective returns – even on optimistic assumptions – at the 2000 peak (see the August 2000 Hussman Investment Research & Insight). While those projections turned out to be perfectly accurate (indeed, the 10-year total return of the S&P 500 was still negative even after the index had nearly doubled from its 2009 low), it also means that the overvaluation of the S&P 500 Index in 2000 was even greater than it is today. As I’ve noted before, the median S&P 500 component is more overvalued today than in 2000, and the average component is similarly overvalued. It’s only the capitalization-weighted valuation that was higher in 2000, primarily because of eye-popping valuations of large technology companies.

In any event, it’s fair to say that valuations could go higher still, and we can’t rule that out. Historically, the emergence of similarly extreme overvalued, overbought, overbullish syndromes (as we also observed in 1929, 1972, 1987, 2000 and 2007) would suggest that the possibility is negligible – but we’ve been punished for our knowledge of history in this cycle. Overvalued, overbought, overbullish syndromes have now been extended without consequence for a much longer period than at any prior speculative extreme. Once you’ve seen a single flying pig, you’re forced to conclude that it’s at least possible for a pig to fly – even if you’re fairly sure it’s only been shot out of cannon.

The best we can do here is to choose one of two courses:

a) speculate that valuations will move still higher, waiting not only for 7-year but 10-year prospective returns to go negative, understanding that those dismal long-term returns will still emerge, but hoping that we can eke out some gains before the well runs dry and we’re forced to beat millions of other speculators to the door, or


b) maintain a defensive stance, recognize that equity risk taken at present levels is likely to produce negative returns on horizons of 7 years and less, and that a 10-year expected annual nominal total return of 1.9% for the S&P 500 is not worth the commensurate risk, but adapt to a world of flying pigs by allowing them to float a bit more freely without raising the safety nets further.

Our choice would be b).

So yes, this time is different. It is different because the Federal Reserve’s zero-interest rate policy has starved investors of all sources of safe return, forcing them to accept risk at increasingly higher prices and progressively dismal long-term prospective returns. More importantly, this time is different because warning signs that appeared at every major pre-crash market peak have persisted and escalated, without resolution, far longer than they have done so historically. Reckless? Shortsighted? Probably. But like dot-com speculation, flipping overpriced houses, and getting a “yield pickup” by holding subprime mortgage debt on margin, reckless and shortsighted speculation always looks like enlightened investment genius until the hammer drops.

Unfortunately, what is not different is that rich valuations are predictably followed by dismal long-term returns, even if short-term consequences are held in suspended animation for a period of time. What is not different is that compressed risk-premiums have a tendency to surge abruptly on events that are either entirely unexpected or, more often, that stem from recognized sources of risk that produce outcomes decidedly more negative than investors had assumed. What is not different is the habit at market extremes for investors to assign elevated price/earnings multiples to earnings that are themselves elevated and unrepresentative of the long-term stream of cash flows their investments will deliver (see Margins, Multiples, and the Iron Law of Valuation). We made these same observations (and debated them with many of the same analysts who deny them today) at the 2000 and 2007 pre-crash peaks, just before the market lost half its value.

With the most reliable valuation measures more than 110% above their historical norms, on average (and allowing that numerous historically unreliable measures look just fine, as Janet Yellen will attest), we remain concerned that equities are no longer competitive even with a very long period of zero risk-free returns. Again, our broad measures of valuation imply a 10-year S&P 500 nominal total return averaging just 1.9% annually, and negative total returns on horizons of 7 years and less. Certain measures imply even worse, including the ratio of market capitalization to GDP, which Warren Buffett observed in a 2001 Fortune interview is “probably the best single measure of where valuations stand at any given moment.” The chart below shows that measure (left scale, log, inverted) against actual subsequent 10-year S&P 500 total returns (right scale).



For greater detail on this and other measures, see my Wine Country Conference presentation “Very Mean Reversion” – and of course, a donation in any amount to the Autism Society of America, the beneficiary of that Conference, would be greatly appreciated.

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kliguy38's picture market crash.....we're too busy building democracies and spreading chaos

Grande Tetons's picture

I have Tulip allergies - John Hussman 

 There, no need to write anymore fucking weekly newsletters. 

Skateboarder's picture

LOLOLOLO. Market Cap / GDP ratio is such a joke metric.

Nowhere do the concepts of positive revenue and positive net income still apply.

disabledvet's picture

"Basis Trading." Not even mentioned here. Interest rates are moving smartly higher in the USA. At some point savers will be more than just rewarded...they'll start looting too!

We just lost a war to "the Taliban" and that has resulted in a massive inflation? I find that one a really hard argument to make to Vox Populii.

max2205's picture

Markets can only crash when there is a republican president.....

Look it up

MrPalladium's picture

Remarkably, while Hussman is absolutely right that "even speculative assets have to compete with zero return assets" his fund shareholders would have been better off if Hussman had parked their assets in zero yielding cash rather than maintaining his portfolio of low PE stocks that excluded all of the hugely overvalued momentum favorites while paying dearly to hedge that portfolio by puchasing puts on an index (SP500) that includes a heavy capitaliztion weighting of those "cocktail party story stocks" and momentum favorites.

Classic hedge mismatch, coupled with a portfolio full of negative relative strength stocks.

Classic formula for the disaster you can see by going to:

type in HSGFX and then select "weekly" rather than daily.

Steady erosion of capital since December 2011. Early is wrong!

Despite the above, Hussman is brilliant, and a must read every Sunday.


SmilinJoeFizzion's picture

Tptb will not let this presidency fail. No market crash until 2017 att he earliest.

Omegaman2211's picture

I'm pretty sure it was a total failure from the onset.

Skateboarder's picture

Failure for us. Success for them.

lunaticfringe's picture

Most accurate comment on the thread. Excellent.

Dr. Engali's picture

The system will crash before the end of his term, what's left of the constitution will be 'suspended' for the common good, and martial law will be declared..... Bank on it.

stant's picture

That's the way I see it to. Clinton didn't make it until the end of his and bush certainly didn't. But this one is Gona be big

NoDebt's picture

Bush almost made it.  But they knew he was good for a bail-out.  I'm not so sure TPTB believe Obama would go along with another bail-out.  Much easier for him to do as Doc said.

Bemused Observer's picture

I'm sure Obama would be just fine with another bailout. As would just about everyone else in the high places. The problem would be when they had to pick the poor slob who would announce it to the public. They'd have to hold that press conference with the speaker wearing full body armor and standing behind 4" thick plexiglass. And they'd have to fly his family to safety before he'd even agree to make the announcement.
Nah...if things get that bad again, it's over, and they know it. There's no more bailing out anybody now. We're ALL on our own. We have no more margins for error that will allow the crippled behemoth we call an economy to drag its dying bulk any further. It will remain where it now lies.

graneros's picture

Hey Doc you could be right.  The one thing that is missing at this point is a BIG war.  Not this regional shit where we kill off a few thousand American soldiers and drain the treasury. They have done their part to be sure but I mean a big ol' ugly war where the daily body count is in the hundreds.  If that happens before 2016 then what you say is virtually guarenteed.

Dr. Engali's picture

That's exactly the way I see it happening. If course there will be one rather nasty false flag to move things along.

disabledvet's picture

"ISIL." Or whatever they changed its name to now. If you're feeling poor just head on over there as a gun for hire.

Heck...bring the whole unit. The price for "armored cars" just went up.

booboo's picture

This presidency has already failed. The stawk market is not the barometer for which millions of unemployed and underemployed are pegging the future, trust me, they know their life sucks even if Brian Williams tells them how rosey the present.

I Write Code's picture

Hussman writes a good article BUT he seems to exclude the most likely scenario, that QE continues to infinity.  He doesn't really state his assumptions, but I presume this would void his negative return prospects for the S&P.

This time is *is* different, and those "seeking yield" only end up with 3% dividends, they are not buying speculative crap paying 7%, they have not bid down the good stuff to 1%.  The likely scenario breaker is only hyperinflation ... or major military hits on the US mainland.

Dr. Engali's picture

Why is it different this time? Why are they in desperation mode? Because we are at the end of the road. Once it all crashes this time that's over mother fuckers..... End of story. Get it? There is no happy ending. We are all fucked.

NoDebt's picture

I always enjoy your optimism.  I think it's worse than that.  

graneros's picture

K..rist on a crutch. I thought I was a pessimist. You've got me way beat NoDebt. And what does that get you? Why a green arrow of course. Barkeep, a green arrow for ND. While your at it get one for The Doc as well. +2

Edit: In fact get a round for the whole house. Uh put it on MDB's tab that sumbitch is probably rolliing in dough.

Cattender's picture

they have been Kicking that Can A VERY LONG TIME...

Dazman's picture

Human behaviour will prevail. It will never be "different" in the sense that the boom/bust outcome will always happen... however they can be muted or exagerated. By adding excess liquidity they theoretically muted the down-leg and exaggerated the up-leg (current leg). However the excess liquidity is being used to build positions that would not have otherwise been possible (by those operaing in the capital markets and those elsewhere [excess consumption]).


but don't worry, it all balances out and as a consequence the next down leg will be rather dramatic... might take a while to come to fruition, but it will happen. All we can do for now is ride the leg up and be on aggressive watch out for the leg down and take positions accordingly.

Grande Tetons's picture

 All we can do for now is ride the leg up and be on aggressive watch out for the leg down and take positions accordingly.

As long as you do not have to sleep and you can stop time...that is a pretty good strategy. 

The Most Interesting Frog in the World's picture

The models Hussman uses would not have worked in the Soviet Union, they would not work in Communist China, and they ain't gonna work in the USSA. Not under the current government and not under this Fed. I'm not saying there will not be a crash, but trying to apply a model to a completely manipulated economy and markets is like trying to place a bet in sports when the game is fixed.

deflator's picture

 Except unlike the organizers of a fixed sporting event the FED comes right out and tells everyone the game is "fixed" and what side to bet on.

LooseLee's picture

Yea, sorta like the Iron Mike Tyson/Buster Douglas rigged fight. It was rigged for Tyson to walk all over him---until reality set in and Douglas decided he wasn't going to be the 'chump'...I remember it well. Still a spiritual experience to watch....

lasvegaspersona's picture

Once one has adequate real wealth then playing in the market to see if it really does go the Zim-bob-way is a fun proposition. If the markets crash you still have your gold (or whatever vehicle you choose to store real wealth). If the S&P is at 30,000 in a year you can try to extract a bit more real wealth from the world and at least pay off a few pesky debts.

I think we are past the era of wheelbarrows full of paper and we will see the efficiency of flash crashes spare a bunch of trees from being turned into pulp (why should trees suffer?) I imagine waking one morning to 'dollar's dead' oh well. We will then see just what the government has been planning. I'll be interested in seeing the reaction of the 10% of the population who thought they had savings. For the average working man with no savings the only question will be 'do I have a job?'

I'm not sure what the modern (virtual, no doubt) version of riots in the streets will be but I plan to watch it on the news safely in my compound surrounded by my moat.


MrPalladium's picture

You are right. What we see now in the stock market is precisely what we would expect to see in the very early stages of a hyper inflation before the extent of the inflation becomes visible and widely recognized. This present stage can continue for a long time because all of the central banks and their currencies are linked to our Fed and to the dollar - until they aren't!

Save_America1st's picture

"The Federal Reserve’s policy of quantitative easing has produced a historically prolonged period of speculative yield-seeking by investors starved for safe return. The problem with simply concluding that quantitative easing can do this forever is that even speculative assets have to compete with zero. When a safe zero return is above the medium or long-term return that one can estimate for a very risky asset, the rationale for continuing to hold the risky asset becomes purely dependent on expectations of immediate short-term price gains. If speculative momentum starts to break, participants often try to get out the door simultaneously – especially if there is some material event that increases general aversion to risk. That’s the dynamic that produces market crashes."



Hence the term or name of this site:  ZeroHedge?????   How prescient.  Hedge accordingly...and stack phyzz to the ceiling cuz this shit is definitely going to end very badly, especially for those who aren't stacking.

disabledvet's picture

We've already had a crash. If you bought Apple debt one year ago you got slaughtered the very next day.

Don't even get me started on Faceplant.

This market correction is WELL underway...the problem comes with looking at everything through the prism of "all time equity market highs."

The beta names have been slaughtered YTD...although some have had a tremendous come back too. But that's like spilling ten thousand scorpions in your "heavy weight match of the century" and then "putting on your shocked face" to imagine the result.

When will we be spared the play by play here? It's PAINFUL just to watch for the few who even do now!

nightshiftsucks's picture

So why was Venezuelas market up 400% ?

BadKiTTy's picture

There is no centrally planned economy that has not come to a sticky end.  

'When?' and 'how sticky?', are the questions which occupy way too much of my time and brain effort.  

I feel like I am watching a late night bad movie that I know is a waste of my time and will have a crap ending, but for some f'ing reason I watch it till the end. Perhaps I live in the hope that my time wont have been wasted and the the movie will turn out not to be crap but awesome (as the ending makes sense of it all). 

It never is..... crap movies are always crap.

Unless they involve piranhas.... and chicks in bathing suits.....


buzzsaw99's picture

i don't believe it is speculation. that's why it keeps going higher. nobody is selling and the algos just keep trading the same hundred lot of shares back and forth. until bag holders are found, and retail is tapped out, the market can't go down. nobody is selling. not the hedgies, not the pension funds, not foreign holders, not the mega rich maggots. unless the fed raises the funds rate significantly to drive out the margin buyers, which they won't, we just melt up higher and higher imo.

Golden Rule's picture

But Krugman just said 2014 is shaping up to be Obama's best year....

AdvancingTime's picture

I'm not a fan of either the former or the latter.

LooseLee's picture

Sadly, there are no 'free lunches'. This market abberation, too, wiill soon pass....

andrewp111's picture

ZIRP makes it impossible to value the market. No valuation measure has any validity. When Treasury yields are at zero, stocks that have some yield can be valued higher by any arbitrary amount. Any number divided by zero equals infinity.  This means stocks can rise without limit, and could crash by a arbitrarily large amount too.

AdvancingTime's picture

Sure does make a person question the value of everything and anything. History is chucked full of distorted markets, debts unpaid, promises unfilled, and bubbles. We seem to be in the middle of a market with very distorted values.

These "interesting times" play havoc with the value of things and what they are worth. Like some of the cruel games children play you don't want to find yourself without a chair or holding the "hot potato" when the game ends. More on this important subject in the article below.

AdvancingTime's picture

Regardless of what you name it the "Federal Reserve Nightmare" or the "Yellen conundrum", the box Ben Bernanke made when he painted both himself and the Federal Reserve in a corner remains. Bernanke has by passing the chairmanship to Yellen escaped from the QE trap but left the rest of us fully in its grasp.

With a policy of loose and cheap money  and an inflation target of just 2% the Federal Reserve  continues to please those gambling that not fighting the Fed guarantees profits. As many Americans are forced to pay higher food, gasoline, and health insurance premiums, I wish someone would let the Fed know we are already there. Any thought that inflation is not higher has come from the false illusion brought from lower payments on things like auto loans and mortgages, this is a one off and will not continue. More on this subject in the article below.

Ban KKiller's picture

Will release more hopium in vapor trails...breath deep.