Warning: John Hussman’s Model Shows the Worst Short Term S&P Risk-Reward in a Century

As last week’s QE3 announcement juiced equities, valuations began to look stretched according to some long-term metrics (such as the Shiller PE, which approached 24). The Bulls certainly proved to be in the majority as the market’s upward move was substantial, but as gold prices surged after the QE3 announcement as well, it was clear that some investors were growing increasingly wary of inflation and general market frothiness.

Enter John Hussman. Never one prone to irrational exuberance, Mr. Hussman’s proprietary model generated crash-warnings in the years 2000 and again in 2007. Then, as now, the model incorporates decades of market data, as well as leading economic indicators, technical indicators and a variety of valuation measures. Some have criticized Mr. Hussman for not being sufficiently bullish in early 2009, though it must be said that his primary objective in trying to outperform in a complete market cycle is the avoidance of large drawdowns, at which objective he is historically adept. And his weekly market comment published today is rather dire.

As of Friday, 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.

Alright, so the technical data and long term valuation data doesn’t look good right now. But even a generally expensive market, with a Shiller PE in the 23 to 24 range, has seen valuations much more stretched than they are at present, implying prospective long term returns are not at a century-long trough. But Mr. Hussman’s model isn’t based purely on valuations and he stresses the intermediate time horizon of his model’s prediction [for more economic news and analysis subscribe to our free newsletter].

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.

Calling a market top is difficult to impossible, and it should be stressed that Mr. Hussman is not calling a market top here, but rather his model is predicting a poor range of outcomes, probability wise, for the market in the intermediate term. He generally advises against knee-jerk activity by long term buy-and-hold investors who have been successful with their discipline in the past. But it must be said, current valuations imply it may be a good time to take some gains. And in light of QE3, $1,700 ounces of gold don’t seem nearly as expensive as they did several months ago. Market weeks such as this one are generally poor ones to overhaul one’s investment strategy, but they are great times to review strategy, make tactical adjustments, and re-balance if necessary.

Don’t forget to subscribe to our free daily commodity investing newsletter and follow us on Twitter @CommodityHQ.

Disclosure: Author is long physical gold, IAU, VYM, and various US equities.

This entry was posted in Commodity ETFs, Gold, Hard Assets and tagged , , . Bookmark the permalink.

Commodity HQ is not an investment advisor, and any content published by Commodity HQ does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities or investment assets. Read the full disclaimer here.

11 Responses to “Warning: John Hussman’s Model Shows the Worst Short Term S&P Risk-Reward in a Century”

  1. [...] prices fell lower across the board as investors digested a worse-than-expected Empire state index report; the figure came in at -10.4 versus the previous reading of -5.9, [...]

  2. [...] investing is one of the safest and most effective ways to add exposure to risky assets like commodities. Options allows users to limit their downside risk while also affording the [...]

  3. [...] It may seem a but over the top to state that nobody should store gold in the states, but his reasoning is sound. With a mountain of debt and a weakening dollar, it seems that QE3 has only delayed the inevitable downturn of our economy. While some feel we may hit a double dip sometime soon, Faber is betting that the collapse will be one of the worst of our time and force the Fed to confiscate gold in order to stay afloat. For those who believe in Faber’s theory, the prospect of moving your gold storage or re-allocating can be a bit scary. Below, we outline several options for gold storage over seas [see also Warning: John Hussman’s Model Shows the Worst Short Term S&P Risk-Reward in a Century]. [...]

  4. [...] funding from the market, or will be unable to continue funding these programs and we will be in a world of hurt. Investors will suddenly realize there is nothing to justify stocks being this high and a massive [...]

  5. [...] time. Between May and September the fossil fuel jumped up roughly 22%, as it had just gotten over a crushing blow that began in the beginning of 2012. But just as it looked like crude was making its way towards [...]

  6. [...] past few weeks have seen a major shake-up in the global economy, as central banks from around the world have taken aggressive actions to try and boost their [...]

  7. [...] addiction, it will work for users until it doesn’t, and when it stops working, there will be a catastrophic system failure. I think QE3 indicates continued money-printing in the extreme, and it’s extending far beyond the [...]

  8. [...] commodities as a source for positive value. Conservative investors quick point to the prospect for volatility that exists when adding commodity stocks to their portfolios may be missing out on the growth that exists in [...]

  9. [...] commodities as a source for positive value. Conservative investors quick point to the prospect for volatility that exists when adding commodity stocks to their portfolios may be missing out on the growth that exists in [...]

  10. [...] Non-Stop Gold: A site that aims to bring you non-stop news concerning this precious commodity. [...]

  11. [...] Non-Stop Gold: A site that aims to bring you non-stop news concerning this precious commodity. [...]

Leave a Reply

  • Subscribe

    • RSS Icon   Twitter Icon
    • Sign up for free today:
  • Search