Monday, June 20, 2011

Hussman Weekly Market Comment: Greek Yields: "Certain Default, But Not Yet"

Over the past few weeks, we've observed a fairly abrupt shift toward weakening across a variety of economic indicators, coupled with a deterioration in market internals. Investors have also placed a great deal of attention on the prospect for a default in Greek government debt. From our perspective, it is important to separate these issues. At least over the near term, the likelihood of a Greek default is quite small. The more pressing issue for investors is that market internals have deteriorated measurably, signaling a shift toward risk aversion among investors in an economy where the scope for further fiscal and monetary intervention is limited, and in a market that remains overvalued on the basis of measures that are actually well-correlated with subsequent market performance.

As usual, I have to emphasize the importance of using historically reliable valuation measures, as opposed to the common but wholly unreliable "forward operating earnings times arbitrary P/E" approach that is the mainstay of market commentators who seem to view historical research as optional. Based on a variety of historically reliable measures (detailed in numerous prior comments), we currently estimate that the S&P 500 is priced to achieve 10-year total returns averaging only about 4.1% annually, which (as a result of the recent market decline) is somewhat higher than the 3.4% we estimated several weeks ago, but remains unsatisfactory from the standpoint of investment merit.

I am not suggesting that the prospect of Greek default is unimportant, but based on the profile of Greek yields across the maturity curve, concerns about a near-term risk of Greek default appear premature. My impression is that a Greek debt default (and an exit from the European Monetary Union) is much more likely to occur in the final phase of the next bear market - not as the opening salvo. The bulk of investor attention at present should be placed on valuations, market internals, and economic factors.