Tags: Hussman | stocks | bonds | Yellen

Hussman: Stocks Need to Fall 55 Percent to Reach Historical Norms

By    |   Monday, 11 May 2015 01:08 PM

The S&P 500 stock index would have to fall by 55 percent to be valued by the most reliable historical measures, said John Hussman, president of Hussman Strategic Advisors.

The fund manager said stocks are expensive in a commentary that scrutinizes a recent comparison of stock and bond values by Federal Reserve Chair Janet Yellen.

“The notion that equity valuations cannot, or will not, revisit normal run-of-the-mill prospective returns (or better) in the coming decade has utterly no support in the historical record,” he said in a May 11 website posting.

“We made similarly ‘preposterous’ but ultimately accurate statements in 2000 and 2007 about the size of the market loss that would likely complete the cycle,” Hussman said.

The stock market reached record highs during those years with the dot-com and housing bubbles. After those bubbles collapsed, the Fed responded with stimulus measures intended to drive down interest rates and help the U.S. economy recover from recession.

The S&P 500 has now risen more than 300 percent since bottoming in March 2009 to a current level of about 2,105 points. The index is trading at a trailing 12-month earnings multiple of about 21 times, higher than the historical average of 16 times. Hussman's call for a 55 percent drop would leave the index at about 900 points.

Hussman said he was encouraged that Yellen last week acknowledged in public remarks that asset valuations are elevated.

However, he questioned whether the so-called ‘Fed Model,’ a term coined by economist Ed Yardeni but not officially endorsed by the central bank, was very meaningful in the longer term.

“The belief that equity valuations are ‘not so high when you compare the returns on equities to the returns on safe assets like bonds’ is a common one, but is based on overgeneralizing a very limited period of history” Hussman said of Yellen’s statements.

“Specifically, the 'Fed Model' — the notion that equity earnings yields and 10-year Treasury yields should move in tandem — is an artifact restricted to the period between 1982 and 1997.”

During that period, bond yields fell because of disinflation, and “equity yields because of what was actually a move from extreme secular undervaluation to extreme secular overvaluation,” Hussman said. “The Fed Model grossly misinterprets these data as if they were a fair value relationship between stock yields and bond yields.”

The so-called equity risk premium, a measure of the stock market’s return compared with risk-free Treasury yields, should be wider to reflect possible risks to economic growth, Hussman said.

“We don’t believe a low growth world will be less susceptible to recession or credit strains, so we also don’t believe that equity risk premiums should be razor thin,” he said. “Investors have priced stocks not only on the expectation of many more years of zero interest rates, but also without any material risk premium at all.”

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The S&P 500 stock index would have to fall by 55 percent to be valued by the most reliable historical measures, said John Hussman, president of Hussman Strategic Advisors.
Hussman, stocks, bonds, Yellen
Monday, 11 May 2015 01:08 PM
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