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John Hussman's "Exit Rule For Bubbles"
Excerpted from John Hussman's Weekly Market Comment,
...which brings us to the present, when I have again become no fun at all, largely because of a combination of high confidence, lopsided bullishness, overvaluation, and an overbought multi-year advance. There’s no question that the absence of consequences – to date – has led investors to believe that those consequences simply will not emerge. Once the consequences arrive, the preceding bubble seems obvious, but it’s a regularity of history that speculative episodes are only completely clear in hindsight. The following chart is a reminder of where we stand. The index is the S&P 500.

History teaches clear lessons about how this episode will end – namely with a decline that wipes out years and years of prior market returns. The fact that few investors – in aggregate – will get out is simply a matter of arithmetic and equilibrium. The best that investors can hope for is that someone else will be found to hold the bag, but that requires success at what I’ll call the Exit Rule for Bubbles: you only get out if you panic before everyone else does. Look at it as a game of musical chairs with a progressively contracting number of greater fools.
Why won’t most investors get out? The answer is that in equilibrium, they can’t. On any given trading day, only a fraction of 1% of total market capitalization changes hands, and the vast majority of that is high-frequency trading and portfolio reallocation between existing equity holders. Think about it – the only way for an investor to get out of stocks without someone else getting in is for the stock to be literally removed from the market. That source of net removal of stock is corporate repurchase activity, which recently hit a year-over-year pace of about $500 billion. That’s still less than 4% of total market cap in an entire year, and it’s a fairly good upper limit on the percentage of investors who will successfully get out of this bubble without the appearance of a miraculous multitude of greater fools at the very moment existing holders decide to sell.
Notably, the heaviest repurchase activity is associated with market peaks – repurchases actually dwindle at market lows. As our friend Albert Edwards across the pond in England points out, corporate cash flow alone is not enough to finance buybacks and other corporate expenditures, so buybacks are instead typically funded primarily through debt issuance. When you recognize that most corporate debt has a maturity of less than 8 years and that market valuations presently imply negative total returns for the S&P 500 over this horizon by our estimates, we believe that corporate repurchases are doing violence, not good, to investors. Moreover, a good chunk of repurchases are used to offset dilution from stock and option grants to corporate insiders. This is like someone saying, “Hey! I made you a pizza!” and then eating that pizza right in front of you.

Notice that heavy equity buybacks (negative values on the red line below) are regularly financed by the issuance of corporate debt (a mirror image of positive values on the black line). Those debt-financed equity buybacks have been heaviest at market peaks like 1999-2000, 2007, and today. Put simply, the history of corporate stock buybacks is a chronicle of corporations buying stock with borrowed money at market tops, and retreating from buybacks at the very points that stocks are most reasonably valued.

In any event, the reason most investors won’t get out of this bubble is that it will require other investors to get in by taking the stock off their hands – and with bearishness running at the lowest level in 27 years, those potential buyers increasingly represent value-conscious investors like us whose demand is likely to emerge only at materially lower valuations.
The good news here is that history also provides every reason to believe that we will encounter repeated opportunities where a material retreat in valuations is coupled with an early improvement in market action. That’s an opportunity that we clearly missed in the most recent market cycle, and my fiduciary inclinations to stress-test our methods clearly did not serve us well under the illumination of hindsight. But one should also remember that to experience a 55% loss, as the S&P 500 did during 2007-2009, one must first lose 30% of one’s funds, and then follow that with an additional loss of over 35%. We don’t intend to take a bath anywhere near what buy-and-hold investors have to brace themselves to endure.
Last week, Investors Intelligence reported that the percentage of bearish advisors has dropped to a 27-year low of 13.3%, a level last seen in 1987 a few months prior to the market crash of that year. Needless to say, investors do not like to hear cautious voices in a speculative market that rewards the absence of caution. We’ve seen a few fairly rude attack pieces by guys who themselves were saying “just buy the market, and wait” at the 2000 peak, and “ignore the calls to action you hear” at the 2007 peak. Though my teenage daughter calls these postings “cyberbullying for adults,” those pieces (minus the incivility) are understandable if one misreads our experience since 2009. That narrative can be understood in context of the two pillars: my stress-testing response to the “two data sets” problem between post-war and Depression era data in 2009 resulted in our missing the best opportunity in this cycle to follow one of those pillars – shifting to a constructive or leveraged position following a material retreat in valuations, coupled with an early improvement in market action. Meanwhile, we are patiently and deliberately adhering to the other pillar – avoiding market risk in the face of an extreme combination of high confidence, lopsided bullishness, overvaluation, and an overbought multi-year advance. The splice of those two invites an oversimplified impression that we are simply permabears. Given that the predictable market losses that follow bubble conditions also have uncertain timing, it’s natural for many to believe that those consequences will simply not arrive. We know that most dismissed those same concerns in 2000 and 2007.
I actually agree very much with the principle that investors committed to a buy-and-hold discipline should stick to that discipline through thick and thin. It’s just that they should understand that “thin” is likely to include another market loss on the order of 40-55% in the next few years, and that the percentage of assets allocated to passive buy-and-hold investments should be aligned with how soon they will need to spend the funds. The S&P 500 presently has an estimated duration of about 50 years, so investors who expect to spend their assets an average of about 15 years in the future should probably not have more than about 30% of assets in unhedged equities. Investors with a 50 year horizon, or who expect to add significant new amounts to their investments over time, can reasonably have a larger allocation. Long-term investors should also recognize that on the basis of historically reliable valuation measures, we estimate 10-year nominal total returns for the S&P 500 of only about 1.5% annually from current prices, so given a 2% dividend yield, we actually expect the index to be lower a decade from now than it is today (see Ockham's Razor and the Market Cycle for a review of these measures).
As value investor Howard Marks observed last week:
“Today I feel it’s important to pay more attention to loss prevention than to the pursuit of gain. Although I have no idea what could make the day of reckoning come sooner rather than later, I don’t think it’s too early to take today’s carefree market conditions into consideration. What I do know is that those conditions are creating a degree of risk for which there is no commensurate risk premium.”
So while many observers pronounce victory at halftime, in the middle of a market cycle, at record highs and more extreme market valuations than at any point except the 2000 peak, remember the two pillars. First, the combination of high confidence, lopsided bullishness, overvaluation, and overbought multi-year advances has predictably been resolved by steep market losses, time and time again across history. Second, strong market return/risk profiles warranting constructive or leveraged investment positions emerge in every market cycle, generally following a material retreat in valuations, coupled with an early improvement in market action. We believe that one of these is descriptive of present market conditions, and the other is well worth our patience.
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S&P to 500! BTFD!!
This time is different.
This time there is a Jewish woman running the printing press and a mulatto president on the television.
This time there is a Jewish woman running the printing press and a mulatto president on the television.
Any chance of swapping them out for Judge Judy and Halle Berry?
it's possibly to show how well a woman does in a typically male role - if she fails will it be seen as a woman thing or just the gift of what was left to her?
Hedge with in the money puts...3x short etfs ect....dont worry be flat
I won't be happy unless I see Obamaites starving in the street. Please crash and let the deflationary depression continue.
She could have done the right thing when she took over and she didn't. She encouraged all the wrong actions in her previous position. So it is 100%her mess.
I figure it ends when the Jewish woman figures that some goy has actually profited a penny.
The best time to leave the theater is before someone yells 'FIRE'
For the last time, there is no spoon.
Exactly!
By "spoon" you mean "market", correct?
The only way to win is by not playing.
throwing gasoline on everyone and lighting a match sometimes works, too.
they can't play the game if they're running around on fire.
metaphorically speaking, of course.
Correction: The only way for you to win is not playing.
Hussman! Hang up the spurs Big Cat, it's over! We livin' in a different world now. New rules when Central Banks control the price of capital. Surprised you haven't gone insane by now.
Exactly!
If Hussman gets bullish, I'm selling everything.
Hussman, 2015 newsletter.
Fuck it! Sell, buy...I do not care. I am going to go snuggle with my cat.
I'm still relevant! I still matter! You still need me!
-JH
SPX weekly - referred to as the gong show formation
http://bullandbearmash.com/chart/sp500-weekly-straight-week-high-central...
but Barry needed to get re-elected so Bernanke / Yellen carried the water
Bubble, Bubble and now BIGGEST BUBBLE.
Doesn't mean its over, just means it keeps going. Buy until the status quo changes, which doesn't seem like anytime soon.
everyone likes to cherrypick their data....why is now any different than '83-'87 or '87-'00 for that matter, some of these charts conveniently leave out those years....its a nominal index thats constantly adjusted and for a guy like hussman to keep using an adjusted "index" to try and empirically prove a point seems disingenuous.
I repeat for the umpteenth time and JH you have been wrong for YEARS. US stocks are not a bubble, not even close. I repeat stocks are going way higher over the next 10 years. Will there be some huge selloffs over the years. Of course!
Huge selloffs should be bought and yes take profits into strength at times to lower risk. I keep saying this and hardly anyone agrees. I also am extremely bullish on gold - bought into weakness of course
Well, I'll agree with you to this point: IF there was a sudden, sharp pull-back. Say, 15% in a matter of days, it would be bought hand-over-fist and quickly recovered. If it was a slow crawl down, like late 07 to late 08, that would probably be reacted to a little differently and more likely to be vulnerable to a more lasting ker-plunk at the end.
So long as there is "no cost" for capital, those who can, most certainly will access it and put it to "work", hence, this market will not stop ramping until physical supply lines break. for example, energy and commodity producers simply cannot deliver, period, for whatever reason. That's where we are. The words capital and work are in quotations because this is the mother of all moral hazards. Weimar was moral hazard on a single country scale and it took a while for the real risk to reveal itself. This is moral hazard on a global scale.
"Huge selloffs should be bought and yes take profits into strength at times to lower risk"
and the sky is blue, and fish live in water, and, and... any more gems you wish to squeeze out, captain obvious?
your insights are so profound i'm guessing you work in finance in some capacity.
Never worked in finance in my life.Never had a finance class. Just have lost alot of money in markets and learned extremely valuable lessons. In Medical field. Captain obvious over and out.
Hell, even the Fed will buy the dips.
They had to borrow in WWII. The central banksters and NWO are taking money everywhere they can in WWIII. That is what the stock market is showing this time.
1920s (Decade)
1933
1945
http://www.hyperhistory.com/online_n2/connections_n2/great_depression.ht...
It's definitely different this time. That's not to say there won't be a correction of some degree, but this time, all of the major global central banks are actively and openly involved in propping up the stock and bond markets. Furthermore, central bank credibilty and future as viable entities are at stake should the markets blow up.
Goldman, Morgan, et al using HFT desks are propping for BABA's PAYDAY , anyone who thinks otherwise hasn't looked at intrday charts, like QQQ, 250K share blocks !
If only John Hussman could generate returns as attractive as his writings he would be a very wealthy man. I bought into his deal for a year or so. At the time he was not able to do as well as the 10 yr coupon rate. Either it is his analysis or his implementation, or both. He has been sticking to that 1% or so S&P forecast for a couple of years now. If the SPY drops 40% from here, I will still be ahead of what he has advised for four years.
Fear not my friends! Janet Yellen will simply monetize more debt and make everything great again!
Water no longer wets and fire no longer burns.
The time to panic is before the Titanic leaves the harbor .
Obviously they know it will crash, but when it does crash they probably believe it will break rank and only drop back to the previous high.
The banks now control the vast amount of the assets and the absolutely control price.
If there is a fall then it will be as a result of bank policy decisions to intentionally crash the market.