Are We There Yet?

For our part, we ultimately adapted to deranged Fed policies by becoming content to gauge the presence or absence of speculative psychology – based on the uniformity or divergence of market internals – without assuming that either speculation or risk-aversion have reliable limits. So yes, this time was different, but in a very dangerous way. Faced with a zero-interest rate world that combined ‘fear of missing out’ with a belief that ‘there is no alternative’ to yield-seeking speculation, investors unwittingly drove the most reliable stock market valuation measures to levels beyond the 1929 and 2000 extremes. Unfortunately, those valuations also imply dismal long-term returns in any world not permanently dominated by FOMO and TINA psychology. Measured from the recent bubble peak, the likely consequence will be a long, interesting, 10-20 year trip to nowhere for the S&P 500. There’s also a strong possibility of an interim loss in the S&P 500 in the range of 50-70% over the completion of this market cycle, or as we observed between 2000-2009, a sequence of cyclical lows punctuated by several extended recoveries.

– John P. Hussman, Ph.D., April 2022, Repricing a Market Priced for Zero

Lao Tzu wrote, “A journey of a thousand miles begins with a single step.” In recent months, the financial markets have taken the first step toward normalization. Unfortunately, having taken one step, the most prominent question we hear is “Are we there yet?!?”

If “there” means valuations anywhere near levels that are consistent with historically run-of-the-mill long-term returns; if “there” means a monetary policy stance anywhere near something that would promote productive capital allocation without speculative distortion; if “there” means financial market capitalizations that can actually be served by the cash flows generated by the economy, providing adequate long-term returns without relying on endless expansion in valuation multiples; then, no. We are not “there.”

The problem is that after a decade of deranged monetary policies that ultimately amplified speculation beyond 1929 and 2000 extremes, we are so far from “normal’ that arriving anywhere near that neighborhood will be a journey. The recent market decline has simply retraced the frothiest portion of the recent bubble, bringing the most reliable market valuation measures back toward their 1929 and 2000 extremes.

For our part, we don’t need to assume, and certainly don’t need to rely, on a return to historically run-of-the-mill valuations, nor would we rule it out. We should allow for periods of market free-fall, as well as “fast, furious, prone-to-failure” advances to clear oversold conditions. Our practice – our discipline – is to remain in the present moment: to align our investment outlook with observable and measurable conditions such as valuations and market internals, and to change our outlook as those conditions change. While the present combination of extreme valuations and ragged market internals creates a “trap door” situation, improvement in the uniformity of market internals could encourage us to lean more constructive even here. No specific forecasts, end-of-year price targets, or scenarios are required.