"US Stocks to Plunge by 64%"

The big short who has accurately predicted the collapse of the US stock market several times is speaking out again, saying that the "recipe" for a stock market disaster has reappeared. The last time this happened, the S&P 500 index plummeted by 25%. This time, we should be alert to an even larger drop...

The notorious bubble prophet John Hussman accurately predicted stock market crashes in 2000 and 2008. Now he warns that special market conditions are signaling trouble, including overvaluation, low investor sentiment, and excessive market technical expansion.

Hussman said that investors have benefited from high valuations and low investor sentiment for some time. But as he sees it now, the last time the market was overextended technically was in November 2021, just a few weeks before the market reached its historical high.

In a report on July 23, Hussman wrote, "The last time we observed a combination of this magnitude was in November 2021, after which the S&P 500 index fell by 25%. Despite the enthusiasm for the market's rebound since last October, I still believe that the 25% drop in the S&P 500 last year will prove to be just the beginning of the most extreme pursuit of profit speculative bubble burst in American history."

The "recipe" for a stock market disaster is back!

In terms of valuation, Hussman likes to compare the total market value of non-financial stocks with their total revenue. He said this is the most reliable indicator he has found to predict future market returns. Although this indicator has fallen from its historical high, it is still at a historical high, indicating an average annual return of -4% over the next 12 years.

The relationship between this valuation indicator and subsequent earnings is shown in the graph below. Generally speaking, the lower the valuation (horizontal axis), the higher the future returns (vertical axis).

In terms of investor sentiment, which is what Hussman calls "market internals," it is a measure of market breadth, that is, how many stocks are currently rising. Weak breadth is a signal that investors are bearish on most individual stocks in the market.

This is Hussman's proprietary measurement method, represented by the red line. When it flattens, stocks (blue line) tend to perform poorly.

How can investor sentiment be so low when the market rebounds to historical highs? One possible explanation is that although investors are not inclined to put money into most stocks of the S&P 500 index, they are very willing to put money into a small number of large technology stocks in the index as these companies compete to develop artificial intelligence technology.This could be the reason for the technical issues that Hessman discovered. His criteria for technical overexpansion include: the 14-day Relative Strength Index (RSI) of the S&P 500 Index being above 70, the rate of change of the S&P 500 Index over the past 14 days being at least 4%, and the S&P 500 Index being at least 4.5% higher than its 50-day average.

As of July 23, all of these criteria were met. When this happens, it usually indicates that the stock market will decline in the near term.

The chart below shows the performance of the S&P 500 Index over the next 40 trading days after meeting these criteria.

But this is a short-term matter. Hessman said that in the long term, the S&P 500 Index could fall by as much as 64%.

The question is, how much does the market need to fall to return to a valuation level that has an annualized return rate of 10% or is 2% higher than the risk-free yield of U.S. Treasury bonds? Although it sounds extreme, when stock valuations are out of sync with U.S. Treasury bond yields or have soared significantly compared to Treasury bond yields, the stock market usually falls sharply.

Compared to Wall Street strategists, Hessman's views are quite extreme. The median target price for the S&P 500 Index at the end of 2023 is 4,300 points, only 6% lower than the current level.

Considering the recent strong rebound, even some of the more pessimistic people on Wall Street have had to raise their expectations. For example, Michael Kantrowitz of Piper Sandler recently raised his target for the S&P 500 Index from 3,225 points to 3,700 points.

However, 3,700 points represent a 19% decline from the current level, and investors would suffer significant losses if it occurs. Some of the arguments that Kantrowitz supports his position are similar to Hessman's views. He believes that the current market valuation is very high, especially when growth expectations are very low.

However, compared to technical factors, macroeconomic fundamentals may be the main driving force for market returns in the coming months.

Signs of a soft landing, such as strong monthly non-farm employment data, low unemployment rates, and healthy GDP, continue to emerge, supporting the belief of bulls. However, the Federal Reserve may still raise interest rates again and commit to keeping rates higher for a longer period to curb inflation, which intensifies concerns that a recession may eventually occur.Previously, Hussman has made headlines on several occasions, predicting that the stock market would fall by more than 60% and that the market would see negative returns for a full decade. Despite the current market continuing to rise significantly, he still adheres to his "doomsday prophecy."

However, before you dismiss Hussman as a wishy-washy "permanent bear," you need to consider his track record:

In March 2000, he predicted that technology stocks would plummet by 83%, and then the technology stock-dominated Nasdaq 100 Index incredibly fell by 83% between 2000 and 2002.

In 2000, he predicted that the total return of the S&P 500 index over the next 10 years could be negative, and indeed it was.

In April 2007, he predicted that the S&P 500 index could fall by 40%, and then the index fell by 55% during the crash from 2007 to 2009.

However, Hussman's recent returns have been less than satisfactory. His Strategic Growth Fund has fallen by about 48% since December 2010, and has fallen by about 4% in the past 12 months. In contrast, the S&P 500 index has risen by about 11% in the past year.

As Hussman finds more bearish evidence, his predictions of a major sell-off in the past few years have begun to prove accurate in 2022.

Therefore, in this new bull market, continuing to be bullish may still yield returns, but when will the greater risk of a crash become unbearable? This is a question that investors must answer, and it is also a question that Hussman will continue to explore during this period.