In today’s Exponential Investor…
- Hussman’s warning
- Man that looks bad
- How investors should respond, with Charlie Morris
Once a leveraged and wildly bullish crowd gets the smallest inkling to sell, the challenging question becomes – “to whom?”
Three things have scared me recently:
- John Hussman’s interim update
- Man Group’s prediction of a market shock
- Rates in a trap – debt vs inflation.
The first piece of news that set me on edge was an interim update published by the brilliant, analytical, patient (and successful) John Hussman, an acclaimed American philanthropist and hedge fund manager.
Whichever way he looks, the only way is down
Usually, Hussman posts just once a month, so it was rare to see an interim update.
He has learned, perhaps the hard way, to steer clear of making forecasts or bold calls about market tops. But his recent statement far more foreboding:
Over the past four decades, I’ve collected scores of interesting syndromes and relationships that tend to occur at market extremes, which I often discuss using terms like “overextension,” “dispersion,” and “reversal.” Occasionally, these are significant enough to prompt an interim update, outside of my regular market comments.
Well, on Friday, November 19, we hit the motherlode. Across four decades of work in the financial markets, and over a century of historical data, I’ve never observed as many historical indications of a market peak occurring simultaneously.
Well, that certainly caught my attention.
He proceeded to run through the data that, alongside his usual valuation metrics, have shown extremely tight correlation to future returns in the past.
The conclusion was just as forceful.
Here and now, market conditions are characterized by:
- The most extreme valuations in US history, on the measures we find best-correlated with actual subsequent market returns over the past century, and even in recent decades, coupled with lopsided bullish sentiment and historic levels of margin leverage;
- Deterioration and divergence across measures of market internals that we believe to be reliable gauges of investor psychology toward speculation versus risk-aversion;
- The largest preponderance of overextended syndromes – typically associated with intermediate or cyclical market peaks – that we’ve ever observed in history.
Not a forecast. Not a “limit.” Not a market call. Just sharing what we’re seeing.
Still, it’s fair to add that we’ve never seen such a thing.
As someone with enormous respect for Hussman and his patient, valuation-focused approach, to see him this nervous about markets really made me sit up.
It’s worth noting that, if we analyse the analyst, it’s not unusual for Hussman to be nervous.
What is notable is that he is far more nervous than usual.
The full piece can be found here, and if you are a bear (like me) then it will confirm your current outlook.
But more importantly, if you think you have nothing to fear in the markets right now, then I’d say Hussman’s piece is necessary reading.
Less stimulus and less bond buying
The second thing that’s given me the jitters is a short note published by Man Group, an excellent investment firm that discusses the end of US fiscal stimulus
The US Treasury issued a heap of bonds when Covid-19 hit, in preparation for the stimulus bills which would require it to spend lots of money.
The Federal Reserve (the Fed) bought most of those bonds.
When people buy bonds from the Treasury, it sucks money out of the system. The Treasury merely deposits the cash it has raised at the Fed.
This equates to a tightening of financial conditions. Money leaves the system and sits in the Federal Reserve… doing nothing.
On the other side, if the Treasury spends the money, it acts as if it is undertaking quantitative easing (QE – when central banks buy government bonds and other securities in order to increase the money supply and stimulate the economy), injecting money back into the system.
This tightening effect was negated in March 2020 because the Fed bought so many bonds. This meant that money was, in turn, created to buy the bonds, instead of existing capital leaving the system.
The last 6-9 months have seen the Treasury spend down its balance, to the tune of almost $200 billion per month. That was spending in US President Joe Biden’s Covid-19 stimulus bill.
The cheques, the cheques…
Its balance had increased by a trillion and a half, and now it’s back to where it was before.
Now? Now there is nothing left. It cannot keep stimulating the economy at this incredible rate.
So from November onwards, there will be a gap where $200 billion of monthly stimulus once was.
In the words of Man Group, “If we are right, then we should be about to see a significant shock in the markets.”
Again, if I am to analyse the analyst, I have never seen one of its weekly notes make such a strong call.
Third, with inflation so high, I have been reminded of the key battle playing out in the markets.
Inflation seems to be coming (or rather, it’s already here – and we just don’t know if it will stick around).
Interest rates would usually rise to reflect this, but they haven’t. At least, not as much as would be reasonable given the high inflation numbers.
But we must remember that before the pandemic, governments the world over were laden with incredible debt burdens, relative to the size of their economies.
Even at the very beginning of 2020, they could hardly afford a rise in interest rates because of how much it would cost them in annual repayments on their massive debts.
But because of the incredible stimulus involved in responding to the pandemic, debt levels have soared to incredible levels across the world.
Now, even the slightest rise in interest rates could leave governments unable to pay off the interest on their debts.
They are in a trap. Inflation can soar, but rates cannot rise to contain it.
That is the framework in which we operate. Yet markets hit all-time highs nearly every day, and Fed chairman Jerome Powell receives the blessing of President Biden for a second term.
This feels like a time for caution, and careful consideration of your portfolio.
I will be discussing these themes and many more with Charlie Morris on this evening’s episode of Southbank Live. It’s at 5pm – you can find it here.
His wealth of experience should prove invaluable in helping to understand and navigate these troubling times.
And he recently spotted a rare, but powerful indicator raising its ugly head once more.
So don’t miss it!
All the best,
Co-editor, Exponential Investor