Hussman shows a risk of 50-66% [US stock]market losses

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Hussman shows a risk of 50-66% [US stock]market losses

Post by jacob » Mon Nov 12, 2018 11:08 am

https://www.hussmanfunds.com/comment/mc181101/ ... maybe an overdramatized title, but people keep asking me what I see as the greatest risk (pile of tinder) in the market and other than FAANG stocks---which are being righteously returned to more normal levels since the beginning of October---the only thing is really the after-effects of QE, that is, the massively leveraged buy-out of the market via stock buy backs, overly high dividends, and just margin buys in general.

IOW, that fact that almost everything is now swimming without pants in a very high tide.

The problem with that is that it's so wide and massive in its influence that it's hard to predict when and even if (too big to fail?) it will go boom. Look at the 5-year expected return plot in the link. (The one that shows -7.5%/yr expected returns). Note that most speculative bubbles were only out of whack in the form of brief spikes. The QE intervention was structural though.

To me this means it's a different beast altogether. For my part, I have less faith that econometrics will properly capture what's going to happen. The reason is that there are [at least] two ways to resolve this going forward and anything-metrics is inherently backward-looking.

"Investors" might have a come-to-Jesus moment in which it's "decided" (much like people decide to evacuate a theater on fire) that paying CAPEs north of 30 is crazy. I'm not so sure about this one. There's no inherent reason why investors can't choose to keep paper assets overvaluated forever as long as it's universally agreed/believed that someone else will always buy them at the same or a higher price. It works for fiat money, so why wouldn't it work for equity securities.

Rising interest rates might trigger this as central banks realize that they need to save up ammo for the next recession. This will put pressure on the leverage as earnings go down because more money is used to pay off short term debt and deleverage to change the mix back. E.g. everybody follows in the footsteps of GE.

In any case, the final piece of advice about strategy-creep is a good one!

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by 2Birds1Stone » Mon Nov 12, 2018 11:49 am

Yikes =/

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by oldtom01 » Mon Nov 12, 2018 3:47 pm

I was just talking to a friend today about how we've both lived, and taken our lumps!, through 2 recessions and how right now feels more like late 2000 than late 2000. January 2001 featured a Super Bowl with several DotCom ads and just months later it was all a smoking hole in the ground.

Similarly sometime in 2008 at the company I was working at that is major major major manufacturer of residential and commercial door hardware all the orders on the residential side suddenly just.... stopped. The prior year had seen raw material costs sky rocketing from what looked like never ending demand and then suddenly it was crickets. I quit that job, almost on the spot, and took a job (with a small paycut!) hiding in the bowels of our state's government IT department and hid from the chaos for 3 years watching as my friends got obliterated by the storm. Took my own losses, but they were minor comparatively speaking.

My father in law timed the market, got out at the top, got back in at the bottom and retired 10 years early a couple of years ago. Good for him. I guess it's an ill wind that blows no one any good after all.

All that to say that I am looking at the 2/3 of my retirement portfolio currently sitting in an indexed mutual fund and getting very nervous. Well, not "suddenly", I've been nervous, but so far housing fundamentals and leading indices have been pretty solid so I've held my fire.

Obviously the balloon is going to go up, and relatively soon (caveat: markets can stay irrational longer than...) but I think we're at least only sideways for a good bit longer (12-18 months?).

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by Seppia » Mon Nov 12, 2018 6:50 pm

jacob wrote:
Mon Nov 12, 2018 11:08 am
In any case, the final piece of advice about strategy-creep is a good one!
Yes, excellent one.
It has been fun seeing Hussman tone down his level of certitude after years of getting slaughtered, for sure he's learnt some lessons.

While I always appreciate reading his commentary, I have to admit I mostly do it to prepare psychologically for the next, inevitable, big drop.
He's been wrong so much, so consistently and for so long that it's almost a statistical achievement by itself. So I kinda simpathize with the man.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by 2Birds1Stone » Mon Nov 12, 2018 9:32 pm

I had to reread the piece again this evening. Stuff like this turns me into a worry wart, and makes me question my whole plan down to it's bones.

I guess that's the whole point of ERE, to prepare in ways outside of just financial assets. Still a bit depressing to think about 10 years of savings/investing getting slashed by 65%.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by Lucky C » Mon Nov 12, 2018 9:36 pm

jacob wrote:
Mon Nov 12, 2018 11:08 am
"Investors" might have a come-to-Jesus moment in which it's "decided" (much like people decide to evacuate a theater on fire) that paying CAPEs north of 30 is crazy.
I believe investors are a lot less rational than implied by this statement. Prices leading up to these extremely high levels are being set by price-insensitive purchasing: automatic 401k contributions in a strong job market, trend-followers who invest solely based on price movements, and fund managers who just follow the trend/herd lest they be fired for underperformance. Prices on the way down are set by price-insensitive sellers: people who are scared they will lose their 401ks, trend-followers whose sell signal has triggered, and fund managers who are again following the herd and trying not to get fired.

I bet roughly 0% of trades in a market top and into a bear market are due to investors realizing that the CAPE is too high. People decide to evacuate a burning theater because they are afraid of getting burned, without stopping to think about how much of the theater will burn in the next 5-10 minutes given the combustibility of the materials around them. Even after the fire, the survivors won't think it's crazy to avoid going to a theater with a pyrotechnics show just because the theater is made of dry wood. After all, fires are few and far between and they were having plenty of fun up until that point.

I work with some of the smartest engineers in the world who typically have hundreds of thousands of dollars invested, likely mostly in US stocks. As smart as they are, I never hear valuations or CAPE mentioned ever. Maybe some of them have heard of CAPE but may not know how it is different than the one-year P/E ratio. Instead I hear them asking why our company stock is dropping 10% over the course of a couple months (as if there is some specific reason rather than just market volatility), I hear people buying AAPL and holding it forever because they like Apple and it goes up faster than other stocks, and I hear comments about the current market volatility as if we just experienced a major bear market and it will most certainly turn around and make new highs soon. When things really go south, they will start selling just because they're scared, or at least stop buying. Either way this little shift from eager buying to selling/holding will force eager sellers to accept lower and lower bids. As panic sets in, more people will be placing market sell orders with no analysis of valuations beforehand. The market cycle can complete with 99% of participants still not understanding CAPE or learning any lessons whatsoever. Rinse and repeat.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by unemployable » Mon Nov 12, 2018 10:53 pm

Yup, it's another Monday here on the ERE boards

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by BRUTE » Mon Nov 12, 2018 11:13 pm

Lucky C wrote:
Mon Nov 12, 2018 9:36 pm
I work with some of the smartest engineers in the world...
just shows there's no such thing as general intelligence

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by Scott 2 » Mon Nov 12, 2018 11:37 pm

The author's funds have poor returns. Why couldn't he figure out how to make a positive return in a 10 year bull market? Doesn't that call his complex reasoning into question?

I wish the markets were rational. Investing would be a lot easier.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by oldtom01 » Tue Nov 13, 2018 10:16 am

Scott 2 wrote:
Mon Nov 12, 2018 11:37 pm
The author's funds have poor returns. Why couldn't he figure out how to make a positive return in a 10 year bull market? Doesn't that call his complex reasoning into question?

I wish the markets were rational. Investing would be a lot easier.
Lol. I wish I had looked at his fund performance before writing my diatribe. How... how do you lose money this last 5 years?

Either way, the point stands that business cycles are real and we really do seem to be at the peak of one, doesn't it?

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by Lucky C » Tue Nov 13, 2018 8:28 pm

You don't need to put faith in Hussman to know that approx. 2x valuation vs. the norm would be a -50% drag on returns if valuations were to go back to normal. Hussman, Shiller, Crestmont, Buffet methods to assess valuation all generally agree that valuations are historically very high.

The risk of 50-66% loss is just to get back to normal valuations and is by no means a lower limit. Depending on the valuation calculation used, current market valuations are 5x to 9x above historic extreme lows. So if we end up touching these extreme lows again, this change in valuation would contribute -80% to -89% to returns. This would amount to around -20% annualized over the next 10 years. Add in dividends and growth and maybe you'd be looking at around -15% annualized total return over the next decade.

If the next bear market is a cyclical bear, the 50-66% loss over the next decade (just to get to normal valuations) is a reasonable expectation. However if we are entering a so-called secular bear market, it is more reasonable to expect losses of 67-80% or more since secular bears end with markets significantly undervalued.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by Jin+Guice » Tue Nov 13, 2018 8:54 pm

This forum has been calling for a crash since 2013 or so. Has anyone figured out how to profit from the coming crash? CAPEs have been high since I've started "investing" in 2015 using strictly VTSAX and whatever the vanguard total bond market index fund is called. Luckily I got lucky. Now y'all have me scared. I'm probably going to sell out this week, ironically waiting for a co-worker to ship me a free phone so I can log back into my vanguard account (current phone is broken and they text me a code every time I log in). #EREproblems.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by slowtraveler » Tue Nov 13, 2018 9:36 pm

@Jin+Guice
Don't overreact, his statement is inaccurate but if it helps you see you're too exposed to equities. If you're scared of 50% losses and negative returns extending 10-15 years, change your asset allocation. Shift 25-75% into bonds like Benjamin Graham recommends if you're really 100% equities or have a look at something like golden butterfly for lower volatility.

100% equities is too much volatility for my taste, 50% crash or not. A small move will ease your tension while keeping you earning money instead of buying back in at a higher valuation in the future if things turn out to keep increasing. Nobody can time the market. I seriously wish I'd started investing by indexing 100%. I'd have 10's of thousands more.

@LuckyC
https://investor.vanguard.com/mutual-fu ... olio/vtsax
5-8x?
PE is 21.2
PB is 3.2
You're exaggerating. PE is not at 30, which would double the historic valuation of 15.

http://www.multpl.com

Buffet himself has said that valuations are in a healthy range in respect to interest rates and recommends a 90/10 S&P 500 to treasury bills or cash to most investors and even has that in his will for his wife.

On the multpl site, look at the pe at 1995, higher than now but with amazing returns for another 5 years.

50% crashes are expected in equities. PE has been 9 before with shitty 10 year returns. 90% crashes are very rare, only has happened with most of the market being leveraged (1929), war, or PE approaching 100 (Japan). Even considering that, 1965 was actually a worse year to retire than 1929 for a US investor due to multiple factors coinciding.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by suomalainen » Tue Nov 13, 2018 10:11 pm

Jin+Guice wrote:
Tue Nov 13, 2018 8:54 pm
Has anyone figured out how to profit from the coming crash?
Buy SPY puts. Or buy SH, which is a daily inverse of SPY. Or if you're feeling really smart, buy the 2x or 3x levered inverse ETFs.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by Seppia » Wed Nov 14, 2018 12:12 am

Levered ETFs are really terrible products as they suffer from decay, meaning in the long run (especially those betting on the downside) have a good probability of converging to a value of zero

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by unemployable » Wed Nov 14, 2018 2:14 am

Seppia wrote:
Wed Nov 14, 2018 12:12 am
Levered ETFs are really terrible products as they suffer from decay, meaning in the long run (especially those betting on the downside) have a good probability of converging to a value of zero
Puts are worse!

If this really concerns you, diversify globally, or into the traditional lower-beta sectors domestically. A lot of these worries are already priced in in other countries.

Usually bonds are another answer, but it sounds like people here are worried about some sort of unholy trinity of collapsing stock and bond markets that isn't accompanied by runaway inflation. So hold cash instead. In a crash not losing money is as good as making it.

Then there's real estate, which in much of the US is, perhaps to the surprise of people living in large metro areas, quite reasonably priced. If they take your house away from you in whatever timeline you're imagining, we're all screwed anyway.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by Seppia » Wed Nov 14, 2018 3:42 am

unemployable wrote:
Wed Nov 14, 2018 2:14 am
So hold cash instead. In a crash not losing money is as good as making it.
This.
I’m a huge fan of keeping things simple.
I AM worried about mid term returns and the possibility of a crash, so I’m simply upping my cash allocation.
The only cost is the opportunity cost of lost returns, the risk is zero.

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by RealPerson » Wed Nov 14, 2018 7:28 am

Seppia wrote:
Wed Nov 14, 2018 3:42 am
I AM worried about mid term returns and the possibility of a crash, so I’m simply upping my cash allocation.
The only cost is the opportunity cost of lost returns, the risk is zero.
Agreed. But the risk for cash is the exchange rate/inflation risk. I obviously want to keep cash mostly in the currency I use to pay for my actual expenses, but diversifying there would be smart also. Now I just have to actually do that. :D

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by thegreatvoid » Wed Nov 14, 2018 8:06 am

When I read a tread like this , I sometimes wish I would bumb my head against something , get amnesia and become a good Shepple , like I used to be .

Critical thinking and intelligence is a evil curse .

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Re: Hussman shows a risk of 50-66% [US stock]market losses

Post by jacob » Wed Nov 14, 2018 8:29 am

Lets return to the final piece of advice which was "avoid strategy creep" + that now is a good time to WRITE DOWN your investment reasoning so you can remind yourself when/if the market does go down^H^H^H^H^H^Hdoes something unexpected. I've prepared a brief statement that fits on an index (ha!) card and covers the beliefs of 95% of the FIRE community.
  • Stocks always go up in the long run.
  • Nobody can time the market.
  • Stockpicking is gambling.
  • John Bogle, Larry Swedroe, Warren Buffett, Burton Malkiel ... says ...
  • Therefore, everyone should regularly buy&hold highly diversified low fee index funds no matter what the market does.
IIRC (and it hasn't changed) what Hussman does is to turn his market exposure (which is not an index) by buying puts and selling calls to cover some of that cost ATM (I don't understand why he doesn't widen the bracket...). This is expensive and the regular "premium" costs are the reason why his fund (HSGFX) shows such a constant/steady decline whenever markets are overvalued.

I used to invest in HSGFX until about 2010 (when I finally pulled everything from all the funds I had and became 100% active). I was never quite clear to me why he was/is unwilling to move his definition of overvalued to fit the market sentiment(*). (I'm sure he's explained it at some point/this is the very point of his strategy/the constraint of running a large fund). You will see that he did spectacularly when the fund was actually operating within the parameter space it was constructed for, but this word was left in 2007 or so. Note that even the market crash of 2008/09 only returned the market [briefly] to normal valuations.

(*) What if the new era normal is a CAPE10 of 20 or 25? This is not unreasonable because each country demonstrates its own normal!

Problem here is that you can't make money in the market by being very right insofar everybody else is simply very wrong. Making money requires an extra component, namely also understanding why they're wrong. It seems trite/pretentious to quote Sun Tzu here, but ...
Sun Tzu wrote: If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.
I highlighted the problem here. This is why (in my opinion) HSGFX's performance = delta flat - "option premium"*time ... because essentially the US stock market has become insane or rather not normal over the past 10 years.

Another way of putting is that (my opinion again), even if one is fundamentally a valuation player (e.g. mean reversion driven), one should not ignore speculation driven markets (e.g. trend driven). IOW, I don't think it's a good idea to be either one or the other. A good strategy has to be able to capture both aspects.

@slowtraveler We're talking CAPE10, not PE TTM or Forward PE. Hussman also uses something similar to CAPE10 as does gurufocus calculations.

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