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Hussman: Not in Kansas Anymore

On April 22 I wrote a commentary titled Austerity/Growth: We're not in Kansas anymore, where I said:

"Rightly or wrongly, I intuitively see the 'macro-economic vortex' spinning ever faster, and think as Dorothy said in the Wizard of Oz, "Toto, I've a feeling we're not in Kansas anymore"."

John Hussman, a former professor of economics and international finance at the University of Michigan, operates The Hussman Funds. On May 27 he published John Hussman: "Not In Kansas Anymore" where I doubt he picked his title by reading my April 22 commentary. Among other things, in his article Mr. Hussman said:

  • in the context of the equity markets "what is most necessary here is simply the recognition that markets move in cycles, that investment conditions will change over time, and that returns born of euphoria are not easily retained" (emphasis added);

  • "we presently estimate that the S&P 500 is about 94% above the level that would be required to achieve historically normal market returns" and "if you work out present discounted values, you'll find that depressed interest rates can explain only a fraction of this differential, even assuming another decade of QE". My comment: Assuming Mr. Hussman's calculations are sensible, this is a very interesting observation - and one participants in the current equity markets ought to think hard about;

  • "at present, valuations are less extreme than they were in 2000, approach levels that were reached in 2007, and remain well beyond those observed at the late-1960's secular peak". My comment: Two of the important variables in any valuation determination are 'cost of capital' and the 'growth expectation'. Currently, as I see things, both the cost of capital and the growth expectation are at 'lower than normal' levels. To some degree the two things are 'offsets'. However, value today is in theory (and ultimately in practice) the 'present value of all future expectations'. That leads to the obvious questions of 'what will be' long term interest rates, real growth, and nominal growth. The current uncertainty around those things makes current valuations much more subjective than they are in more 'normal' times;

  • "holding hours worked constant, the U.S. economy would have lost the equivalent of 550,000 to 600,000 jobs in April". My comment: Assuming Mr. Hussman's calculations are meaningful, this is a 'quite scary' comment;

  • "excitement about improvement in the federal deficit is largely driven by several on-off factors and quite rosy assumptions" and "projections of further deficit reductions are predicated on assumptions that" (1) health cost inflation will be controlled, (2) corporate tax revenue growth of 57% and 88% in 2014 and 2015 respectively), and (3) in coming years real GDP growth will increase to 4% while inflation stays at 2%. My comment: Clearly, from everything I read and consider it seems to me that if Mr. Hussman's information is at all reasonable, the required assumptions are 'euphoric at best';

  • "the Pavlovian response of investors to monetary easing ... fails to distinguish between liquidity and solvency; between economic activity and market speculation; and between investment value and artificially depressed risk premiums". My comment: That is the best and most succinct summary I have seen of my own beliefs. I consider Mr. Hussman's comment with respect to 'artificially depressed risk premiums' to be particularly important;

  • "the 3-month (U.S.) Treasury yield now stands at a single basis point. Unwinding this abomination to restore even 25 Treasury bill rates implies a return to less than 10 cents of monetary base per dollar of nominal GDP. To do this without a balance sheet adjustment would require 12 years of 6% nominal growth (presumably, from Mr. Hussman's previous comment, comprised of 4% real growth and 2% nominal growth), a more extended limbo of stagnant economic growth like Japan, or significant inflationary pressures - most likely in the back half of this decade. The alternative is to conduct the largest monetary tightening in the history of the world". My comment: Assuming Mr. Hussman's calculations to be reasonable, this puts things into a very 'bleak perspective' going forward;

  • "valuations and monetary conditions are far removed from what is sustainable, and there is more evidence to indicate that the (U.S.) economy is weakening than support of the idea that it is strengthening";

  • "we are now in a very mature, unfinished half of a market cycle spectacularly distorted by monetary and fiscal imbalances. The prospects that the financial markets will face over the next few years are quite unlikely to mirror the lovely ones that they enjoyed while these imbalances were being established" (emphasis added); and,

  • "recovering a 20% loss requires a 25% gain, and recovering a 25% loss requires a 33% gain, but recovering a 50% loss requires a 100% gain, and recovering the market's Depression-era loss required a 600% gain". My comment: I suggest this comment is particularly important, as it once again puts into perspective what I have commented on many times in this Newsletter - namely that discussion as to percentage change typically is less relevant than is discussion in 'absolute amounts'.

The foregoing quotations represent but a comparatively small part of Mr. Hussman's commentary. No one I have spoken with in the past two months about the continuous rise of the U.S. equity markets has disagreed with me that those markets are disconnected from what is happening in the macro-economy. Moreover, not one of those people has been able to provide any reason for this disconnection other than saying that demand for equities is driving up equity prices.

I continue to think about the equity markets in the context of yield and risk. Investing an unhedged $100,000 today might, if one did well, generate an 'after-fees' and before tax return of (say) 3.5%. $3,500 of taxable income strikes me as a very small return when measured against the risk of the equity markets and the macro-economy becoming better aligned - at least as I see the current non-alignment of those two things.

If you participate in the financial markets I suggest you take the time to read John Hussman: "Not In Kansas Anymore", and consider carefully what Mr. Hussman says.

The current equity markets continue to strike me as akin to an enormous game of 'musical chairs'. In my view anyone participating in these markets ought not to stray 'too far from a chair', as pity those who don't find a chair if the music stops.

Reference: John Hussman: "Not In Kansas Anymore", from AdvisorAnalyst, John Hussman, May 27, 2013 - reading time 8 minutes.


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