Last week I highlighted John Hussman’s contrarian view of the market. Hussman’s market commentary this week is full of more pearls of wisdom that are worth highlighting. And no, he has not turned bullish:
The present environment is characterized by unusually overvalued, overbought, overbullish conditions, with rising 10-year Treasury bond yields, heavy insider selling, valuations on “forward earnings” appearing reasonable only because profit margins are more than 70% above historical norms (fully explained by the negative sum of government and personal savings as a share of GDP), with the S&P 500 at a 4-year market high, in a mature market advance, with lagging employment indicators still positive but more than half of all OECD countries already in GDP contraction, Europe in recession, Britain on the cusp, and the EU imposing massive losses on depositors in order to protect lenders in an unstable banking system where Cyprus is the iceberg’s tip. Investors have assumed a direct link between money creation and stock market performance, where provoking yield-seeking and discomfort among conservative investors is the only transmission mechanism of a nearly-insolvent Fed. Investors have assumed that stocks can be properly valued on the basis of a single year of earnings reflecting the benefit of massive fiscal deficits, depressed household saving, and extraordinary monetary distortion – when the more relevant long-term stream of earnings will enjoy far less benefit. Historically, extreme overvalued, overbought, overbullish, rising-yield syndromes have outweighed both trend-following and monetary factors, on average. For defensiveness to be inappropriate even in this environment, investors must rely on the present instance to be a radical outlier.
I especially like his notion of “The Hook”, a term that appears to be coined by Richard Russell:
“Every bull and bear market needs a ‘hook.’ The hook in a bear market is whatever the bear serves to keep investors and traders thinking that everything is going to be all right. There is always a hook.” – Richard Russell, Dow Theory Letters, November 2000 (S&P 1400)
The “hook” today is the dramatically elevated, deficit-induced level of profit margins. While the complete faith of investors in the Federal Reserve may prove to be the hook for ordinary investors, it’s not enough to draw in more careful observers. The real hook, in my view, is the absence of a bubble in any individual sector, and instead a bubble in profit margins across the entire corporate sector. That is the hook that serves to keep investors and traders thinking that everything is going to be all right.
Buyer beware. Do yourself a favor and go read the entire piece here.