In his September 17th weekly market comment titled “Low Water Mark“, my favorite economist, John Hussman writes:
“As of Friday, [ed.: 9/14/12] our estimates of prospective return/risk for the S&P 500 have dropped to the single lowest point we’ve observed in a century of data. There is no way to view this as something other than a warning, but it’s also a warning that I don’t want to overstate. This is an extreme data point, but there has been no abrupt change; no sudden event; no major catalyst. We are no more defensive today than we were a week ago, because conditions have been in the most negative 0.5% of the data for months. This is just the most negative return/risk estimate we’ve seen. It is what it is.
Since we estimate prospective return/risk on a blended horizon of 2-weeks to 18 months, we are not making a statement about the very long-term, but only about intermediate-term horizons (prospective long-term returns have certainly been worse at some points, such as 2000). As always, our estimates represent the average historical outcome that is associated with a given set of conditions, and they don’t ensure that any particular instance will match that average. So while present conditions have been followed by extraordinarily poor market outcomes on average, there’s no assurance that this instance can’t diverge from typical outcomes. Investors should ignore my concerns here if they believe that the proper way to invest is to bet that this time is different.”
“Last week, we observed a syndrome of evidence that matches only a handful of market extremes in history, including August-December 1972, August 1987, April-July 1998, July 1999, and March 2000, and April-July 2007. Investors with a good sense of market history will recognize all of those instances as points from which subsequent outcomes were steeply negative, even if stocks held up or advanced moderately over the short-run. With regard to the potential for steeply negative outcomes, we find that when we look across history, conditions similar to the present have been “enriched” with steep declines – another way of saying that the negative tail of the distribution is very fat here.
For example, if we break our estimates of prospective market return/risk into five quintiles or “buckets”, present estimates are clearly in the most negative bucket. Historically, 31% of instances in that worst bucket have been followed by a market decline of at least 10% over the following 6 month period, while 41% of all 10% market declines (occurring within a 6-month period) have started from instances in that bucket. In other words, while the lowest quintile captures 20% of the historical data, that bucket captures 10% market corrections more than twice as often as one would expect if those 10% declines were randomly distributed across market conditions. Similarly, the periods in the lowest quintile of prospective return/risk capture 45% of all 15% market declines that have occurred within a 6-month window, 54% of all 20% market declines, 69% of all 30% declines, and 87% of all declines of 35% or more (what would commonly be considered “crashes”).
In short, saying that our estimates of prospective return/risk are negative does not indicate that the market will or must plunge. Rather, it says that the average outcome has been quite negative, and the likelihood of extreme “tail events” is vastly enriched compared with more typical conditions throughout history.”
This is somewhat in conflict with my last post about Tom Demark’s short-term bullish call of 1478 on the S&P 500 before the November election. Of course, Demark makes a very short-term call while Hussman is speaking of ‘intermediate’ returns of up to 18 months.
Regardless, I’m not finding anything of value to invest in at the moment, which leaves me around 47% in cash (15% gold, 32% stocks).