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Hussman Warns Beware ZIRP "Hot Potatoes": Examine All Risk Exposures
Excerpted from John Hussman's Weekly Market Comment,
Present conditions create an urgency to examine all risk exposures. Once overvalued, overbought, overbullish extremes are joined by deterioration in market internals and trend-uniformity, one finds a narrow set comprising less than 5% of history that contains little but abrupt air-pockets, free-falls, and crashes.
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"Abrupt market weakness is generally the result of low risk premiums being pressed higher. There need not be any collapse in earnings for a deep market decline to occur. The stock market dropped by half in 1973-74 even while S&P 500 earnings grew by over 50%. The 1987 crash was associated with no loss in earnings. Fundamentals don't have to change overnight. There is in fact zero correlation between year-over-year changes in earnings and year-over-year changes in the S&P 500. Rather, low and expanding risk premiums are at the root of nearly every abrupt market loss.
“One of the best indications of the speculative willingness of investors is the ‘uniformity’ of positive market action across a broad range of internals… I've noted over the years that substantial market declines are often preceded by a combination of internal dispersion, where the market simultaneously registers a relatively large number of new highs and new lows among individual stocks, and a leadership reversal, where the statistics shift from a majority of new highs to a majority of new lows within a small number of trading sessions.
“This is much like what happens when a substance goes through a ‘phase transition,’ for example, from a gas to a liquid or vice versa. Portions of the material begin to act distinctly, as if the particles are choosing between the two phases, and as the transition approaches its ‘critical point,’ you start to observe larger clusters as one phase takes precedence and the particles that have ‘made a choice’ affect their neighbors. You also observe fast oscillations between order and disorder in the remaining particles. So a phase transition features internal dispersion followed by leadership reversal. My impression is that this analogy also extends to the market's tendency to experience increasing volatility at 5-10 minute intervals prior to major declines.”
Market Internals Go Negative, Hussman Weekly Market Comment, July 30, 2007
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“We've started to see the pattern of abrupt jumps and declines at 10-minute intervals that is often a hallmark of nervous markets. My continued concern is that numerous market plunges have been indifferent to both interest rate trends and even valuations, with the main warning flag being deterioration in the quality of market internals, as we observe at present. Both in the U.S. and internationally, ‘singular events’ tend to occur well after internal market action has turned unfavorable, and prices are well off their highs.
“Though I don't want to put too much emphasis on intra-day behavior, if you examine tick data or daily ranges before major declines both in the U.S. and elsewhere, you'll generally see price movements become chaotic at increasingly short intervals even before the event itself. One way to describe it without mathematics is to spin a quarter on the table and watch (and listen to it) closely - you'll observe a similar dynamic at the abrupt point that the coin moves from an even spin to an irregular one, and again just before it stops. If you imagine a pen drawing out its movements, you would see it tracing out faster and faster circles as it moves from stability to instability.”
Broadening Instability, Hussman Weekly Market Comment, January 28, 2008
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In recent weeks, the market has transitioned to the most hostile return/risk profile we identify: the pairing of overvalued, overbought, overbullish conditions with deterioration in market internals and price cointegration – what we call “trend uniformity” – across a wide range of stocks, sectors, and security types (see my September 29, 2014 comment Ingredients of a Market Crash). As in 2007 and 2000, we’re observing characteristic features of that shift. One of those features is that early selling from overvalued bull market peaks tends to be indiscriminate, as deterioration in market internals and the “average stock” often precedes substantial losses in the major indices. As of Friday, only 28% of NYSE stocks are above their respective 200-day moving averages.
In the current cycle, both the Russell 2000 small-cap index, and the capitalization-weighted NYSE Composite set their recent highs on July 3, 2014, failing to confirm the later high in the S&P 500 on September 18, 2014. Through Friday, the NYSE Composite is down -7.3% from its July 3rd peak, and the Russell 2000 is down -12.8%, while the S&P 500 is down only -4.0% over the same period. What’s happening here is that selling is being partitioned in secondary stocks, and more recently high-beta stocks (those with greatest sensitivity to market fluctuations). Market action is narrowing in a classic pattern that reflects the effort of investors to reduce risk around the edges of their portfolios, in what typically proves an ill-founded belief that a falling tide will not lower all ships.
Abrupt market losses are typically not responses to obvious “catalysts” but instead reflect a shift in investor preferences toward risk aversion, at a point where risk premiums are quite thin and prone to an upward spike to normalize them. That’s essentially what’s captured by the combination of overvalued, overbought, overbullish coupled with deteriorating internals. Another characteristic of these shifts is increasing volatility at short intervals – what I described at the 2007 peak and in early-2008 by analogy to “phase transitions” in particle physics. The extreme daily and intra-day market volatility in recent sessions is typical of that dynamic.
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No doubt – this pile of zero-interest hot potatoes has helped to compress risk premiums across the entire range of risky assets toward zero (and we estimate, in some cases, below zero). But understand that the bulk of the advance in financial assets in recent years has not been a reasonable response to the level of interest rates, but instead reflects a dangerous compression of risk premiums.
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In short, every 3-month period of additional zero-interest rate policy promised by the Fed is worth about a 1% premium over historical valuation norms. Another year would be worth a premium about 4% over historical norms. But with the market more than double historical norms on reliable measures, the Fed would have to promise a quarter of a century of zero interest rate policy before current stock valuations would reflect a “reasonable” response to interest rates. No – stocks are not elevated because low interest rates “justify” these prices. They are elevated because the risk premium for holding stocks has been driven to zero. We presently estimate negative total returns for the S&P 500 on every horizon shorter than 8 years.
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Though we should allow for a potential improvement in market conditions, I do believe that now is a particularly bad time to rely on the idea that “this time is different” with money you cannot afford to lose. This does not require forecasts about market direction – only proper consideration of market risk. Make sure that the portfolio of risks you do hold is the portfolio that you want to hold over the completion of the market cycle, understand the risk profile and actual losses that various asset classes have experienced over prior market cycles, take account of the prospective returns that are embedded into current valuations, and insist on historically reliable measures of valuation that demonstrate a strong association with actual subsequent returns over numerous market cycles across history.
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Investors should understand that “prices and valuations are high” is another way of saying “future returns have already been realized, leaving little to be gained for quite some time.”
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hussman post, therefore 3% ramp up this week;)
as far as zirp goes: if something is truly valuable you don't give it away for free do you?
I see lots of plus 100 PE stawks about to turn into gas soon
You mean this is the wrong time to go all in on Twitter?
Growth is slowing. That's pretty much it.
http://www.planbeconomics.com/2014/10/marc-faber-investors-recognizing-g...
Portfolio:
Gold, Silver, Bitcoin?
He said, "protect yourself from(government and CB conjured) inflation".
Hot Potatos, eh?.... We getting better economic advice from The Wiggles than from the gartmans.
I believe they're also long Fruit Salad:
https://www.youtube.com/watch?v=gB4MNu6W9sg
Well, two out of three ain't too bad...
Probably.
Ever notice I-Shares IWM DISCLAIMERS? " All companies with p/e over 60 shall be set at 60" ? That's not all, try to find it, small print!
It's only given to the already rich at 0% to buy stawks and luxury goods. Everyone else has to deal with money that is still scarce.
all the comments, thoughts, more comments.
zh snob - you got it. if it's worth something, you give it away free? that's just it. thanks so much.
you want 10 dollars? here - have another 10. for free.
So what this illiterate, mumbling fool is trying to say is, when markets go down, they go down. Geez, thanks buddy, I never would have guessed.
S&P contract open on futures; 1884 and 65,000 contracts vol. so far. just opened. Somewhat bearish ?
Sell buy some Bitcoin rember the private key and sleep well at night.
I've noticed over the years that computer programmers only understand computer languages; and they never get around to finding out anything about how the real world works.
In other breaking news, the President has signed a deal to play himself in a movie about his greatness once he leaves office. Rumors are flying that he may be awarded an Oscar before his movie is even released..........
They already made a movie about him just up to being elected it was called being there . Peter sellers played the role. Chancy the gardener
Hussman Weekly Market Comment---so he gets paid for this useless blabbing ? wow; I never knew how easy it was to make a living. I think all the newsletter writers should be banned from ZH; this is just bullshit.
I did not see the word "Ebola" in the entire article. What a disappointment!
Often longer-term strategists, however brilliant, can lack short-term savvy, and vice versa.
Monday’s lower holiday volume seems ripe for a possible short-but-severe mini-squeeze, particularly in the Russell and Q’s, given machines like to torture once-a-year retail shorts who think a can’t-miss plunge is heralded by this weekend’s doom articles.
Of course, daytraders will wait for technical confirmation before going long, but from what I’ve witnessed in the past, should a snap-back RUT screamer come, it will eclipse in a single day what we’ve seen on the down days recently. Whenever IWM directional trading gets easy, a WTF day is more likely. Will it be “different this time”?
EDIT: Gartman on CNBC Asia tonight, he's worried, 'neutral', recommends cash. Contraindicator?
The short squeeze alone will create a hockey stick. Good for me because I want the VIX in the 11's again for another move over 17.
Everyone has been conditioned to expect the "invisible hand" to swoop in and sticksave the S&P 500. Pavlovian responses to six-years of interventions by 133 Liberty include "BTFD", "it's different this time", "Fed's got our back", and denial. Just like 2000, 2007 and 1987. Sell everything not nailed down. (except gold and silver and Aussie and Canadian bonds)
Lot of retail people I know sold all their stocks last week.
One would think. The thing is to sell rallies; I know it seems impossible but until the very last day, there are rallies; they might rally three days this week; you just don't know.
Monday is low-volume machine-driven trading
Dimon speaks on Tuesday
Draghi on Wednesday
Bullard on Thursday
Yellen on Friday
Result?
You know the drill--btfd's
we need more pictures of playful kittens.
Not necessarily; the market is open. period. and right now we see a fuck of a lot of volume in the S&Pfutures; it doesn't look machine like at all. the machines aren't programmed to lead the parade they're supposed to get hints and follow on.
It might soon become apparent the economic efficiency of credit is beginning to collapse and the additional money poured into the system coupled with lower rates can no longer drive the economy forward. When this happens we are at the end game.
At some point the return on loaning money is simply not worth the risk! Why do you want to loan money if most likely you will never be repaid or repaid with something that is totally worthless? When this happens the only safe place to store wealth will be in "tangible assets" and the only lenders will be those who print the money that nobody wants.
The collapse of credit can pose major problems such as what we saw when many sellers were forced to demand payment up front before shipping goods in 2008. More on this subject below.
http://brucewilds.blogspot.com/2014/06/the-economic-efficiency-of-credit...
What is interesting about this Hussman piece is the combination of rhyming "poetry" (history doesn't repeat but it rhymes) - where his previous observations in 2007 are relevant today. Then he THROWS in this bit that doesn't rhyme!!
<< No doubt – this pile of zero-interest hot potatoes has helped to compress risk premiums across the entire range of risky assets toward zero (and we estimate, in some cases, below zero). But understand that the bulk of the advance in financial assets in recent years has not been a reasonable response to the level of interest rates, but instead reflects a dangerous compression of risk premiums. >>
THEREFORE: This time is different. The CBs have distorted WW markets by forcing deployment into riskier and less liquid asset classes. Thus investors resemble the lumbering French forces in the battle of Agincourt, thinking that their CB armor will protect them. But the battle is fought in a plowed field, and many of the French fighters became stuck in the mud and many drowned in the helmets after falling down. (think of liquidity here :-). The English archers are the hedge funds, who undoubtedly are looking on this whole scene with clear eyes. The longbows are out now, and it will be pretty easy pickings for the hedgies and the squiddlies to pick off the lumbering investors and pension fundies as they attempt to exit their muddy positions. Hussman says "air pockets" are possible. Looks to me more like repeated massacres. But "no bubble here", only softened and wet soil from the liquidity rained down from CB helicopters.
the only thing worse than being so smart and leaving 20%+ returns on the table these four years past is buying Au/Ag & mining stocks
and watching your p/f drop liike Pb