- John Hussman is calling for a 65-70% drop in the S&P 500.
- He says he sees “fresh deterioration” in a key market indicator.
- His comments come as stocks sit at record highs amid euphoric investor sentiment.
- Visit Business Insider’s homepage for more stories.
Investors are by now conscious of the heightened risk of a stock-market pullback in the near future, given the euphoric speculation that has continued to drive valuations upwards.
Eighty-nine percent of financial professionals surveyed by Deutsche Bank earlier this month said that they saw bubbles in financial markets, and Bank of America and Charles Schwab both recently warned that investor sentiment is approaching extremes, making stocks vulnerable to a sell-off.
But if market conditions are solid, over-enthusiastic investor sentiment by itself often isn’t enough to make the market liable to a downturn. When investors should become worried is if indicators start to deteriorate, according to Charles Schwab’s Chief Investment Strategist Liz Ann Sonders.
“Where you tend to get a bigger problem is if sentiment is really, really elevated, and then you start to see a brisk deterioration in the market but sentiment just stays optimistic,” Sonders told Business Insider in December.
“That to some degree is what happened in the early part of 2000,” she added. “You started to see some underlying deterioration in what was going on in the market, but sentiment was like, ‘nope, doesn’t matter, it’s a new paradigm.'”
That underlying deterioration may now be here, says John Hussman, the notorious market bear and president of the Hussman Investment Trust.
An indicator that measures “market behavior in ‘debt securities of varying creditworthiness,'” has started to weaken as it has before previous market crashes, he said in his most recent market commentary posted on January 18.
“Interestingly, those debt-sensitive components were also the first to shift negative at the 1987 and 1929 peaks. The equity components shifted later. I often describe unfavorable shifts in market internals as being driven by ‘deterioration’ and ‘divergence,'” Hussman said.
“In 1987 and 1929, the ascent to the bull market peak was so steep and indiscriminate that there was little ‘divergence’ in the equity components at the highs,” he continued. “Instead, the equity components shifted only after a sharp, near-vertical initial loss.”
Hussman is calling for a jaw-dropping crash ahead: a decline of 65-70%. In addition to the shift in market internals, the S&P 500’s drastic departure from valuation norms means it’s due for a drop, he said.
He laid out the scenario in the below chart. The blue line represents S&P 500 price action, while the green line represents the index’s valuation norms.
With sentiment and valuations at highs, and with the “fresh deterioration in our key gauge of market internals,” Hussman said a recipe for disaster is coming together, especially if that deterioration continues.
“Put simply, the present constellation of market conditions creates the potential for the sort of ‘trap door’ situation we observed in March,” he said.
Hussman’s track record — and his views in perspective
While there are growing concerns about the exposed position that current stock valuations and investor sentiment are putting markets in, Hussman’s call for a 65-70% drop is still extraordinary.
Just about every major Wall Street institution expects the S&P 500 to rise in 2021.
But Hussman’s position is usually in the margins.
For the uninitiated, he has repeatedly made headlines by predicting a stock-market decline exceeding 60% and forecasting a full decade of negative equity returns. And as the stock market has continued to grind mostly higher, he’s persisted with his doomsday calls.
But before you dismiss Hussman as a wonky perma-bear, consider his track record, which he broke down in a recent blog post. Here are the arguments he lays out:
- Predicted in March 2000 that tech stocks would plunge 83%, then the tech-heavy Nasdaq 100 index lost an “improbably precise” 83% during a period from 2000 to 2002.
- Predicted in 2000 that the S&P 500 would likely see negative total returns over the following decade, which it did.
- Predicted in April 2007 that the S&P 500 could lose 40%, then it lost 55% in the subsequent collapse from 2007 to 2009.
However, Hussman’s recent returns have been less-than-stellar. His Strategic Growth Fund is down about 50% since December 2010, though it’s risen more than 11% in the past year.
Still, the amount of bearish evidence being unearthed by Hussman continues to mount. Sure, there may still be returns to be realized in this market cycle, but at what point does the mounting risk of a crash become too unbearable?
That’s a question investors will have to answer themselves — and one that Hussman will clearly keep exploring in the interim.