Hussman Market Comment

The defining feature of every bubble is the same: a growing inconsistency between the long-term returns that investors expect in their heads - based on extrapolation of the past, and the long-term returns that properly relate prices to likely future cash flows - based on valuations. Every bubble smuggles the same tragic past into the same tragic future by packaging it with new wrinkles that convince investors that this time is different. Ultimately, they still end the same way.

The S&P 500 stands at the most extreme level of valuations in history. This record aligns precisely with the happiest and most satisfying moment of a speculative bubble: the point where wildly misaligned expectations for market returns are being realized anyway – via self-fulfilling speculation. From an equilibrium standpoint, record corporate profits and free cash flow, particularly as a share of GDP, are the mirror image of record deficits in the government and household sectors. This isn’t a theory. It’s an accounting identity. Sustaining record corporate surpluses requires sustaining record government and household deficits.

Division by zero is known as a 'singularity.' It’s the point where equations break down, values become 'indeterminate,' things stop working normally, and variables shoot toward infinity and suddenly collapse on the other side. The current speculative bubble was driven by a singularity. Avoiding the crash on the other side relies on the willingness of investors to accept the lowest long-term return prospects in U.S. history, forever. Extremely high prices may seem like a beautiful thing, but they’re a corrupt bargain. Unless you actually sell, the cost of “enjoying” record high valuations is that you are locking-in record low future rates of return.

Bubbles are generated when investors drive valuations higher without simultaneously adjusting expectations for future returns lower. In other words, the defining feature of a bubble is inconsistency between expected returns based on price behavior and expected returns based on valuations. The “Bubble Term” measures the gap between the two. Unless the Bubble Term is able to become exponentially larger forever – it shows up as a growing gap between the long-term return that investors expect in their heads, and the long-term return that investors can actually expect based on the future cash flows that will ultimately be delivered into their hands.

With our most reliable stock market valuation measures at the highest extremes in U.S. history, record negative readings on our most reliable 'equity risk premium' gauge (estimated S&P 500 total returns vs. Treasury yields), and the narrowest junk bond risk premiums in history, it’s useful for investors to remember that a market crash is nothing but risk-aversion meeting a market that is not priced to tolerate risk. Emphatically, nothing in our investment discipline relies on a market collapse, or even a reversion of valuations to levels anywhere near historical norms. Particularly with the hedging implementation we introduced last September, I expect it will be enough simply for the market to fluctuate.

If you look deeply into a speculative bubble, you can see the market collapse in it. If you look deeply into a market collapse, you can see the bull market in it. Each is a continuation of the other.

In recent years, our most reliable measures of stock market valuation have pushed beyond their 1929 and 2000 peaks, and I’ve described the period since early 2022 as the extended peak of the third great speculative bubble in U.S. history. In my view, that process is now complete. The stock market faces severe downside risk ahead, and the U.S. is constrained in the unsystematic monetary and fiscal expansion that both amplified that bubble and fueled record but wholly impermanent corporate profit margins. Meanwhile, the U.S. economy now faces an imminent recession, and if we fail to be vigilant, we, once united Americans, risk losing what is far greater and more valuable than money.

With regard to the record ratio of financial market capitalization to GDP, the government deficits of the past eight years have bloated the corporate profits on which investors are placing extreme price/earnings multiples while calling it 'stock market capitalization.' Meanwhile, the highest income earners have also accumulated the cash and securities that the government issued to finance the deficits. As a result, the massive deficits of recent years are a significant portion of what the deepest pockets presently call 'wealth.'

It’s enormously tempting to imagine, at bubble highs, that glorious backward-looking returns, far greater than those previously implied by valuations, demonstrate that historical standards of value are outdated and obsolete. In 1934, Benjamin Graham and David Dodd described the mood surrounding the 1929 market peak, observing that investors had abandoned their attention to valuations because 'the records of the past were proving an undependable guide to investment.' For the moment, neither valuations nor arithmetic matter to investors. As Galbraith observed, 'As long as they are in, they have a strong pecuniary commitment to belief in the unique personal intelligence that tells them that there will be yet more.'