The Fast and the Furious

"Valuations are informative about long-term returns and full-cycle risks. Market internals are informative about investor psychology over shorter segments of the cycle. Presently, neither valuations nor internals are favorable, and that is what opens up a trap door under the market. There will certainly be periods where short-term oversold conditions will enable scorching market rebounds (what we typically describe as “fast, furious, and prone to failure”), but the strongest market return/risk profiles we identify will be associated with points where a material retreat in valuations is joined by an early improvement in our measures of market action. – John P. Hussman, Ph.D., The Heart of the Matter, Nov 2018"

Given the steep market decline in recent days, short-term market conditions clearly qualify as “oversold” and highly compressed, in my view. Beyond the short-term, the main considerations here are that 1) market internals continue to be ragged and divergent; 2) the most reliable valuation measures (those most strongly correlated with actual subsequent 10-12 year market returns) remain extremely elevated from the perspective of history and even of recent market cycles, and; 3) credit spreads continue to widen, with European banks still being a central concern.

All of this indicates that investors remain inclined toward risk-aversion in a steeply overvalued market. That in a nutshell, is the “reason” behind this decline, and those conditions – particularly the ragged internals – have been in place for months. Most of the “explanations” you hear for this decline are simply events that prompt investors to simultaneously take actions that were ultimately baked-in-the-cake anyway.

While we don’t presently observe conditions to indicate a “buying opportunity” or a “bottom” from a full-cycle standpoint, we do observe conditions that are permissive of a scorching market rebound, even if it only turns out to be the “fast, furious, prone to failure” variety. I say “permissive” because there is no certainty about a rebound, and we wouldn’t dream of removing our safety nets against a market decline that I continue to expect to draw the S&P 500 toward the 1000 level by the completion of this cycle. Still, we’ve prepared for the possibility of unusual volatility here, most likely including one or more daily moves in the range of 4-6%, potentially to the upside. Yes, that means one or more daily moves on the order of 100-150 points on the S&P 500 and 900-1300 points on the Dow. You think I’m kidding.