Tag: Bear Market

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Visual Summary: John Hussman’s Case for a Market Crash

John Hussman of Hussman Funds is pretty bearish. Others are bullish. But I think it’s investing best practice to listen to both the optimists and pessimists. Only then can you approach the markets with a balanced perspective.

In his most recent market commentary, Hussman makes several points that shouldn’t be ignored. His most recent commentary is quite long, so I’ve provided a visual summary of his key points and charts below:

Valuations are at record highs for all stocks (not just an especially expensive segment of the market). The chart below shows price-to-revenues broken down by decile. Across the entire range of valuations, all segments are at record price-to-revenue ratios.

S&P 500 median price-revenue ratios by valuation decile

The same is true when breaking down the market by market capitalization. Small, medium and large cap stocks are all trading at record valuations.

S&P 500 median price-revenue ratio by market capitalization

Companies with negative earnings in particular have skyrocketed in valuation. This speaks to investor focus on the future. Unfortunately, expectations – like during the Internet bubble – often go unrealized, and lofty valuations eventually fall back to Earth.

Goldman Sachs non-profitable technology basket

As an investment strategy, hope is prevalent in the IPO market too. New issues – such as the recent Bumble IPO, which jumped 64% on the day of listing – shoot to the moon. Yet, many of these companies barely have any earnings (or even revenues in many cases) to speak of. Again, investors are flocking to IPOs in the hope of profiting off massive future potential.

Renaissance new issues index

Investors are so confident in the future they are willing to borrow to place their bets. Accordingly, margin debt as a proportion of GDP is at record levels! Borrowing to invest is a risky strategy. While one can profit handsomely investing other people’s money during a bull market, once asset prices turn it can lead to poverty. Moreover, the collective level of margin debt tends to exacerbate market declines as investors clamor to liquidate at the same time.

Margin debt to GDP

The US stock market capitalization is at record highs relative to US GDP. The value of companies relative to the value of what they produce has risen immensely.

Total equity market capitalization to GDP

Perhaps these charts don’t concern you because you’re a ‘long-term’ investor. Well, they should.

Valuations tend to be a pretty good predictor of future returns. The chart below maps Hussman’s estimated 12yr forward returns against actual forward 12yr returns – you can see the fairly tight relationship. Currently, Hussman’s model is forecasting a forward annualized 12yr return of -2.15%. Yes, negative. And yes, it is possible that long-term returns are negative because it has happened before. Moreover, historical periods of negative long-term returns tend not to be graceful and orderly. Rather markets violently oscillate between upward momentum and downward spirals.

Estimated 12-year total return for a passive 60/30/10 portfolio allocation (Hussman)

Is Hussman right this time? I don’t know. Nobody can predict the future. And the future doesn’t have to look like the past. So who’s to say that valuations don’t stretch even further? Or that revenues and earnings climb rapidly to close the valuation gap?

I don’t know. You don’t know.

But what I do know is that history shows the risks are real. Hussman is observing rhe signposts.

I’m not arguing there will be a crash tomorrow. Yet, the probability of one grows as valuations are stretched and investors gain confidence.

My suggestion to all investors is to keep your confidence in check. If you start to feel highly confident in your investing prowess you may be taking on too much risk. Great declines are often preceded by great hubris. Be aware of your own behavioural biases and remind yourself that investing in stocks could mean losing 50% of your money at any point in time. And no, you’re not good enough to get out at the right time.

If Hussman’s market return projections are right, individual investors will perform far worse. Most investors tend to plough more money into investments near market peaks and withdraw money near market bottoms, experiencing all the downside and missing out on upside.

Consequently, most investors could have real world experiences far worse than -2.15% annualized over the next dozen years.

Read John Hussman’s full commentary.

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Investing

Chart: Market Recovery vs Past Bear Markets

The coronavirus crash was fast and sharp. It recovered within months – the best recovery when compared to past bear markets.

The speed of the recovery is likely due to the speed and volume of Federal Reserve support, which exceeded all previous monetary stimulus programs.

Some argue that the massive volume of support indicates we are approaching the end game for the credit based system. Others suggest the Fed has learned from previous policy mistakes – namely, underestimating the required magnitude of stimulus. Perhaps if the Fed were more decisive in 2008/2009, the post-GFC recovery wouldn’t have taken so long.

Honestly, there are great arguments either way. I don’t know. But what I do know is the US dollar remains the reserve currency by a wide margin and its status has not been compromised by the recent monetary stimulus. This tells me that the demand for dollars more than makes up for the additional supply.

Some suggest we are in the middle innings of a secular bull market that began around 2014 or so, led by emerging technologies in cloud computing, automation, artificial intelligence and machine learning. Looking at previous market cycles, this is quite possible. In hindsight, we can see that the 2000-2012 period was essentially a sideways market. During that time the S&P 500 price level went nowhere, and it is exceedingly rare that a 12yr consolidation would be followed by another one. It’s more likely a 12yr consolidation would be followed by a secular bull market.

Of course, on a total returns basis the post-2000 experience wasn’t as bad. When including reinvested dividends, the S&P 500 broke even by 2006.

Maybe we’re in a secular bull market. Maybe we’re not. As a dumb and lazy investor I’d rather not try to time the market. Instead, I feel more comfortable, regardless of the market environment, if I own a diversified assortment of businesses that are 1) reasonably valued, 2) will survive the test of time, and 3) reward shareholders with growing dividends and share buybacks.

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Investing

Why is The Market At All Time Highs?

Many people right now are wondering why the stock market is at all time highs while the economy is in recession. I too wondered if this were an anomaly created by excessive Fed printing. So I looked to see if something similar has happened before.

As it turns out, during the 1981-1982 recession, the stock market (blue line in chart below) hit an all-time high after recovering from significant losses.

During the 1981-1982 recession, the return to stock market all time highs occurred close to the end of the recession as unemployment (maroon line) peaked.

Of course, the end of the 1981-1982 recession was only known later in hindsight, so people likely asked the same questions they are today. What they could not see was that the market approached all-time highs because the recession was close to ending. While the transition to growth was slow and painful – as I expect it to be today – with unemployment taking years to return to normal, the markets rallied once economic growth resumed.

The return to growth (second chart below) in 1982 is easily identified by unemployment (maroon line) beginning to fall and Industrial Production (blue line) starting to rise (second chart below). This occurs right near the end of the recession, as indicated by the grey shading.

Industrial Production is a great indication of economic recovery. As you can see (if you have good eyesight) in the chart below is that at the end of every recession (grey shading) Industrial Production immediately grew. The second chart below zooms into the current recession. It is clear that Industrial Production has started to grow once again while unemployment has started to trend down. This indicates the current recession likely ended in April or May and growth has resumed, explaining the stock market’s return to all time highs. (Note the entire period is shaded until the recession’s end is officially retroactively declared months later.) Again, this growth doesn’t feel like growth because we’re rebuilding from an uncomfortable bottom, but the market only cares that things are growing.

The 2020 recession was sharp, deep and short. Markets reacted accordingly and crashed faster and deeper than ever before. The recovery will be long and painful, but we are back on the growth path. Markets sniffed this out months ago explaining the rally. Markets hit all-time highs in 1982 – when unemployment was near its peak. The same thing is happening today.

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Investing

14 Ideas from Howard Marks to Help You Invest in this Bear Market

If you are wondering how to invest during this bear market, this article is for you.

Investing during a bear market isn’t easy. However, it is when good money can be made. Although it might feel like the world is falling apart and markets are riskier than ever, in reality the risk of investing is actually reduced AFTER stocks have already plummeted. In contrast, the most risky time to invest is when investing feels most comfortable.

Do you wait for the bottom? What if you’re too early or too late? How do you even know when a bottom has occured?

Howard Marks, Director and Co-Chairman of Oaktree Capital shares his valuable insights on how to invest during a bear market. He is a market veteran so he’s seen a few bear markets and financial crises in his day.

howard-marks

Howard Marks, CFA
Director & Co-Chairman
Oaktree Capital

Since the formation of Oaktree in 1995, Mr. Marks has been responsible for ensuring the firm’s adherence to its core investment philosophy; communicating closely with clients concerning products and strategies; and contributing his experience to big-picture decisions relating to investments and corporate direction. From 1985 until 1995, Mr. Marks led the groups at The TCW Group, Inc. that were responsible for investments in distressed debt, high yield bonds, and convertible securities. He was also Chief Investment Officer for Domestic Fixed Income at TCW. Previously, Mr. Marks was with Citicorp Investment Management for 16 years, where from 1978 to 1985 he was Vice President and senior portfolio manager in charge of convertible and high yield securities. Between 1969 and 1978, he was an equity research analyst and, subsequently, Citicorp’s Director of Research.

Below are several quotes taken from Howard Marks’ recent market insight pieces available on the Oaktree Capital website:

  1. These days everyone has the same data regarding the present and the same ignorance regarding the future.
  1. Future scenarios comprise a large number of variables: today even more than usual. It’s relatively easy to build a spreadsheet listing the many things that will contribute to the future and rate them as likely to turn out well or poorly. But merely toting up the plusses and minuses won’t tell you whether the future will be favorable or unfavorable. The essential element is figuring out which ones will be most influential. That’s often where optimistic or pessimistic biases come in. The optimist takes cheer from the favorable outlook for the positive data points, and the pessimist is depressed by the unpleasant possibilities for the negative ones . . . even if they’re both working from the same underlying spreadsheet in terms of elements and ratings.
  1. I don’t think I’m likely to have superior knowledge regarding the outlook for the virus, its impact on the economy, the success of Fed/government actions or the direction of oil prices. I organized and discussed the possibilities for each of these things in the March memos, but I’m unlikely to be a better predictor than anyone else.
    1. Buy, sell or hold? I think it’s okay to do some buying, because things are cheaper. But there’s no logical argument for spending all your cash, given that we have no idea how negative future events will be. What I would do is figure out how much you’ll want to have invested by the time the bottom is reached – whenever that is – and spend part of it today. Stocks may turn around and head north, and you’ll be glad you bought some. Or they may continue down, in which case you’ll have money left (and hopefully the nerve) to buy more. That’s life for people who accept that they don’t know what the future holds. But no one can tell you this is the time to buy. Nobody knows.
    1. The best time to buy generally comes when nobody else will; other people’s unwillingness to buy tends to make securities cheap. But the factors that render others averse to buying will affect you, too. The contrarian may push through those feelings and buy anyway, even though it’s not easy. As I put it, “All great investments begin in discomfort.” One thing we know is that there’s great discomfort today.
    1. “The bottom” is the day before the recovery begins.Thus it’s absolutely impossible to know when the bottom has been reached . . . ever.Oaktree explicitly rejects the notion of waiting for the bottom; we buy when we can access value cheap. Even though there’s no way to say the bottom is at hand, the conditions that make bargains available certainly are materializing. Given the price drops and selling we’ve seen so far, I believe this is a good time to invest, although of course it may prove not to have been the best time. No one can argue that you should spend all your money today . . . but equally, no one can argue that you shouldn’t spend any. The more you want to garner potential gains and don’t mind mark-to-market losses, the more you should invest here.On the other hand, the more you care about protecting against interim markdowns and are able to live with missing opportunities for profit, the less you should invest.
    1. One way to think about the balance between offense and defense is to consider the “twin risks” investors face every day: the risk of losing money and the risk of missing opportunity. At least in theory, you can eliminate either one but not both. Moreover, eliminating one exposes you entirely to the other. Thus we tend to compromise or balance the two risks, and every individual investor or institution should develop a view as to what their normal balance between the two should be.
    1. Now, however, as opposed to the conditions of 2, 6, 12 or 24 months ago the risks in the environment are recognized and largely understood, prospective returns have turned from paltry to attractive (for example, the average yield on high yield bonds ex. energy has gone from 3½% to almost 9%), security prices have declined, and investors have been chastened, causing risk-taking to dry up.
    1. Given these new conditions, I no longer feel defense should be favored. Yes, the fundamentals have deteriorated and may deteriorate further, and the disease makes for risk (remember, I’m the one who leans toward the negative case). But there’s a big difference between a market where no one can find a flaw and one where people have given up on risk-taking. And there’s a big difference between one that’s priced for perfection and one that allows for bad outcomes.
    1. …we never know when we’re at the bottom. A bottom can only be recognized in retrospect: it was the day before the market started to go up. By definition, we can’t know today whether it’s been reached, since that’s a function of what will happen tomorrow. Thus, “I’m going to wait for the bottom” is an irrational statement. If you want, you might choose to say, “I’m going to wait until the bottom has been passed and the market has started upward.” That’s more rational. However, number one, you’re saying you’re willing to miss the bottom. And number two, one of the reasons for a market to start to rise is that the sellers’ sense of urgency has abated, and along with it the selling pressure. That, in turn, means (a) the supply for sale shrinks and (b) the buyers’ very buying forces the market upward, as it’s now they who are highly motivated. These are the things that make markets rise. So if investors want to buy, they should buy on the way down.
    1. The old saying goes, “The perfect is the enemy of the good.” Likewise, waiting for the bottom can keep investors from making good purchases. The investor’s goal should be to make a large number of good buys, not just a few perfect ones. Think about your normal behavior. Before every purchase, do you insist on being sure the thing in question will never be available lower? That is, that you’re buying at the bottom? I doubt it. You probably buy because you think you’re getting a good asset at an attractive price. Isn’t that enough? And I trust you sell because you think the selling price is adequate or more, not because you’re convinced the price can never go higher. To insist on buying only at bottoms and selling only at tops would be paralyzing.
    1. So it’s my view that waiting for the bottom is folly. What, then, should be the investor’s criteria? The answer’s simple: if something’s cheap – based on the relationship between price and intrinsic value – you should buy, and if it cheapens further, you should buy more.
    1. I don’t want to give the impression that it’s easy to buy while prices are tumbling. It isn’t, and in 2008, Bruce and I spent a lot of time supporting each other and debating whether we were buying too fast (or too slow). The news was terrible, and for a good while it seemed as if the vicious circle of financial institution meltdowns would continue unchecked. Terrible news makes it hard to buy and causes many people to say, “I’m not going to try to catch a falling knife.” But it’s also what pushes prices to absurdly low levels. That’s why I so like the headline from Doug Kass that I referred to above: “When the Time Comes to Buy, You Won’t Want To.” It’s not easy to buy when the news is terrible, prices are collapsing and it’s impossible to have an idea where the bottom lies. But doing so should be the investor’s greatest aspiration.
    1. The bottom line for me is that I’m not at all troubled saying (a) markets may well be considerably lower sometime in the coming months and (b) we’re buying today when we find good value. I don’t find these statements inconsistent.

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    Investing

    Why Gold is Declining

    The number one question I’ve received this week: why is gold down with the stock market?

    Fair question. Gold is sold as a form of protection against calamity. Were we really sold ‘fools gold’?

    Probably not.

      Gold has a tendency to decline during crises. One only has to look at 2008 for a recent example.

      In 2008, gold prices declined along with everything else. However, after the immediate crisis ended gold prices started a dramatic rise, reaching a record high (around $1900) in 2011.

      So why does gold fall during severe market stress? There are a few possibilities:

      1. Forced selling to cover margin calls.

      As markets collapse, anyone who bought stocks on margin (i.e. borrowed from their broker) will need to put up additional collateral or sell their holdings. Those who don’t want to sell need to add cash to their accounts. On way to do this is to sell holdings that have performed well. Up until last week, gold was performing exceptionally well.

      2. Sell winners.

      Investors sell their winners not only to fund margin calls. They might sell winners so they have cash to redeploy into cheaper stocks. Or they may simply want to increase their cash buffer. Investors tend to sell winners because it is psychologically easier to lock in a gain than a loss.

      3. Rising dollar.

      Most financial crises are accompanied by a dollar shortage. One reason is because investors are reallocating to US Treasuries (which require dollars to buy). The US dollar (and the dollar-denominated Treasury market) is viewed as a safe haven in times of crisis. This causes the value of the dollar to rise. When the value of the dollar rises, the number of dollars required to purchase any asset priced in dollars declines. Gold is priced in US dollars.

      What’s next?

      If this crisis plays out like the last one, central banks will eventually inject massive liquidity into the financial system, which is ultimately good for gold.

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