Notorious Market Bear Warns Stocks in ‘Third Great Speculative Bubble’

• John Hussman warns of negative S&P 500 returns over the next decade.
• Hussman’s analysis shows the market capitalization of nonfinancial stocks at all-time highs.
• Hussman’s called the 2000 and 2008 bubbles, but his fund’s performance has been poor.

John Hussman probably isn’t someone you want to take investment strategy advice from.

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The president of the Hussman Investment Trust is seemingly always bearish, even in enduring market rallies, and his Hussman Strategic Market Cycle Fund (HSGFX) is down 55% since December 2010.

But Hussman does produce some interesting valuation analysis that’s frequently cited by investing legend and GMO cofounder Jeremy Grantham, and now may be a good time to take stock of where the market sits historically, and what that could mean for future returns.

After all, the S&P 500 is coming off back-to-back years of at least 23% gains. Valuations have now climbed back to their 2021 peak levels. Inflation concerns are also rising as the economy remains strong, pushing up 10-year Treasury yields, which eventually tend to weigh on expensive equity markets.

Earlier this week, Hussman published his latest monthly report and pointed out that his ratio of market capitalization of nonfinancial stocks to total gross value-added has hit all-time highs.

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Hussman deems the measure the most reliable for predicting 10-year subsequent returns. Like the Shiller CAPE ratio, it does provide a forecast of future returns.

Here’s a chart from Hussman’s December note showing that relationship. Current levels put forecast annualized returns over the next decade at around -6%.

“Our most reliable gauges of market valuation continue to trace out what I view as the extended peak of the third great speculative bubble in U.S. history — implying the most negative prospects for expected S&P 500 total returns on record,” Hussman wrote in the January 7 note — the 1929 and 2000 peaks being the other two speculative episodes.

Hussman is not alone is his downbeat long-term outlook, though his forecasts are more dire than most. Goldman Sachs’ Chief US Equity Strategist David Kostin said last year that the S&P 500 would likely produce just 3% annualized returns over the next 10 years. Morgan Stanley CIO Mike Wilson said returns would be “flat-ish” over that time.

Another way of looking at how extreme valuations are is considering them in context with 10-year Treasury yields. Investors can generate risk-free annualized returns of 4.76% right now. Meanwhile, as shown above, long-term return prospects are meager. By Hussman’s calculations, stocks will underperform 10-year Treasurys by 11% per year over the next decade. The last two instances where return prospects were this poor were in 1929 and 2000.

“As always, you’ll see ‘errors’ in this chart, in this case reflecting valuation extremes at the endpoint of certain 12-year horizons. If we assume and rely on market valuations remaining at record extremes 12 years from today, we can also assume that actual equity returns in the coming 12 years, relative to bonds, may be better than our estimate below,” Hussman wrote, the emphasis his. “Still, even the largest ‘error’ in history would not push the resulting 12-year risk-premium above zero.”

One thing to note regarding Hussman’s arguments is that they rely heavily on what has happened in the past, while this market cycle has proved that is not always a foolproof approach. For example, perfect recession indicators like The Conference Board’s Leading Economic Index, the inversion of the Treasury yield curve, and the Sahm Rule all seem to have been wrong this time around. Conditions change, and investor excitement around where artificial intelligence will take the market in the future may be right on track. Or, of course, we could get a repeat of something like the dot-com bubble.

“The only way to get here, at the outer reaches of history, was to advance, undaunted, through every lesser extreme,” Hussman wrote. “My impression is that it will end badly, not just because current valuations assume favorable developments, but because they require outcomes that are at odds with history, economics, and financial arithmetic,” he added, the emphasis again his.

Hussman’s track record — and his views in context

For the uninitiated, Hussman has repeatedly made headlines by predicting a stock-market decline exceeding 60% and forecasting a full decade of negative equity returns. And as the stock market ground mostly higher, he persisted with his doomsday calls.

But before you dismiss Hussman as a wonky perma-bear, consider again his track record. Here are the arguments he’s laid out:

• He predicted in March 2000 that tech stocks would plunge 83%, and then the tech-heavy Nasdaq 100 index lost an “improbably precise” 83% during a period from 2000 to 2002.
• He predicted in 2000 that the S&P 500 would probably see negative total returns over the following decade, which it did.
• He predicted in April 2007 that the S&P 500 could lose 40%, then it lost 55% in the subsequent collapse from 2007 to 2009.

Hussman’s recent returns, however, have been less than stellar. His Strategic Market Cycle Fund is down 9.6% in the past 12 months. The S&P 500, by comparison, is up about 22% over the past year.

The amount of bearish evidence being unearthed by Hussman continues to mount, and his calls over the past couple of years for a substantial sell-off began to prove accurate in 2022. Yes, there may still be returns to be realized in this new bull market, but at what point does the mounting risk of a larger crash become too unbearable?

That’s a question investors will have to answer themselves — and one that Hussman will keep exploring in the interim.