Friday, June 5, 2009

Hussman Weekly Market Comment: Anything But Academic

I’m a little late getting to this, but I think it is another good piece from John Hussman.

Presently, however, the debate about the long-term economic fallout from this defense of bank bondholders is anything but academic. I recognize that I have been on a virtual rant about it in recent months, but the reason is that it is literally the most important fiscal and bureaucratic event that we are likely to observe in our lifetimes, and is very possibly the precursor to enormous future economic difficulties. You simply cannot have an economy lend out trillions of dollars in bad debt, and then make the lenders whole with public funds (while still facing a massive second wave of probable mortgage defaults) without destructive repercussions. There is very little chance, in my view, that the current downturn is over. We have enjoyed a nice reprieve – if over a trillion dollars in redistribution could not accomplish even a reprieve, it would be a surprise. It's clear that investors are hopeful that we can simply return to rich valuations, debt-financed economic expansion, and abnormal profit margins based on excessive leverage. From my perspective, this hope is as thin as those that we observed at the peak of the internet bubble, the housing bubble, and the profit margin peak of 2007.

As I noted last week, our risk measures have shifted from a borderline neutral stance to a fresh defensive stance. From a valuation perspective, stocks are slightly overvalued except on the basis of earnings-based metrics that assume a quick return to 2007 profit margins. Stocks are not richly priced, but they are no longer compressed in valuation. They are also no longer compressed from a technical perspective, and are instead overbought on a variety of measures. Without compression to allow prices to advance as a sort of “release valve,” the market now relies on actual improvement in the economy – not simply news that is “less bad than expected.” That's not to say that we can rule out such improvement, but at this point, the market relies on it. For our part, the average return-to-risk profile of the market, given current conditions, does not justify much risk taking. Moreover, in view of the larger picture of economic and credit conditions, the risks are lined up clearly to the downside. The stock market features unimpressive valuation, overbought conditions, and a reliance on positive surprises and easing risk aversion. That sort of market certainly can continue higher, but the potential for further return comes with a great deal of potential risk.


Related previous post: Exploding debt threatens America – by John Taylor