Hussman's Hint Of Advance Warning
Excerpted from John Hussman's Weekly Market Comment,
Historically-informed investors are being given a hint of advance warning here, in the form of a strenuously overvalued market that now demonstrates a clear breakdown in internals. We observe these breakdowns in the form of surging credit spreads (junk bond yields versus Treasury yields of similar maturity), weakness in small capitalization stocks, and other measures.
These divergences have actually been building for months, but rather quietly. Note, for example, that as the S&P 500 pushed to new highs in recent weeks, cumulative advances less declines among NYSE stocks failed to confirm those highs, while junk bond prices were already deteriorating.
We don’t take any single divergence as serious in itself, but the accumulation of divergences in recent weeks should not be ignored. Notably, the majority of NYSE stocks are now below their respective 200-day moving averages (which again, isn’t serious in itself, but feeds into a larger syndrome of internal breakdowns in a market that remains strenuously overvalued).
After an extended and extreme compression of risk premiums, we’re now observing increasing divergences across a variety of market internals and security types (e.g. breadth, leadership, momentum stocks, small caps, junk bonds).
We’ve come to avoid pointed warnings in this market, because speculative conditions have extended much longer than in other cycles. Indeed, we’ve had a few deteriorations in recent years that reversed fairly quickly as investors shifted back to risk-seeking, particularly after fresh initiatives or assurances about monetary easing (though further initiatives may not be forthcoming in this instance). So we're open to a favorable shift on these measures, and if that was to occur following a somewhat greater retreat in valuations, it could even open up some amount of constructive opportunity. Meanwhile, despite our view of stocks as severely overvalued, our response is to remain defensive without taking a stance that greatly relies on immediate market weakness.
An awareness of divergence and uniformity is the bread-and-butter of signal extraction – inferring true information signals from the sea of random noise. We take the present breakdown of market internals seriously.
Whatever the crowd wishes to do about it, historically-minded investors should think carefully about whether a strenuously overvalued market with deteriorating market internals is a desirable environment for risk taking. For our part, the answer is a resounding “No.”
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