John Hussman: The Importance of Understanding the Tenuous Equilibria of the Markets

Adam Taggart
By Adam Taggart on Thu, Apr 18, 2013 - 7:09pm

At the Wine Country Conference in Sonoma, California two weeks ago, John Hussman gave a presentation on the importance of equilibrium in today's markets.

Many of the conference attendees were at the conference specifically to hear John speak, as he so rarely makes public appearances like this (his Hussman foundation made the event, which raised funds for the Les Turner ALS Research Foundation, possible). And John did not disappoint.

John spoke on the various types of equilibria in today's financial markets. There are many different types, and it's through the understanding of which ones we're faced with that we can begin to accurately predict the most probable outcomes. Because these outcomes themselves (including the "endgame" outcome) are each a type of equilibrium -- likely much more stable ones than that of today's markets.

(If this seems a little wonky, just watch John's example using chairs to demonstrate fragile, unstable and stable equilibria at 7m:22s, and all will be clear)

John dispels several popular but erroneous market myths along the way, including the concepts of "buyers outnumbering sellers" or "money moving into/out of a secondary market".

His punch-line is that our financial markets actually have a natural equilibrium state that is far removed from where they are today. But interfering monetary policy (e.g. QE) and delusional fiscal policy have pulled the system away from its authentic state, to the point now where the forces to correct are placing growing strain on the status quo. As the system seeks to return to where it should naturally be, the yields that the Fed is so desperately trying to engineer are going to become less in size and number.

Investors need to realize that much of the "growth" the Fed is trying to return to was manufactured and unnatural. We are returning to a lower-growth environment, whether we want to or not.

Hussman Wine Country Conference

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4 Comments

KugsCheese's picture
KugsCheese
Status: Diamond Member (Offline)
Joined: Jan 2 2010
Posts: 1449
Slides?

Adam, can you post the slides?   I had a hard time reading some on the video.  TIA

SailAway's picture
SailAway
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davefairtex's picture
davefairtex
Status: Diamond Member (Online)
Joined: Sep 3 2008
Posts: 5456
hussman's talk - very thought provoking

Thanks for posting this article.  I loved it.

Hussman is big macro thinker.  He sees things in 30 year cycles, and in some sense may not be the best guy to be running a fund since its difficult to follow the current trend and match quarterly SP500 performance if you are focused on the 30 year timeframe.  But I'd bet he'll protect you from actually losing money over the longer term when the black swans hit.

The equilibrium stuff was ok, but there was other material in his presentation that I found even more compelling.

The chart he had (that I went out and verified for myself) that really impacted me most is his total return projections.  It took repeated viewings - pause, think, rewind, play again - run some numbers - pause again - for me to have it all sink in.  But once it did, the import of what he was saying was utterly convincing to me.

Let me explain.

He uses a projection of an expected 10 year ROI on the equity market -  "the next 10 years of equity market returns" - as being reasonably predicted by some combination of the average PE ratio over a 10 year period plus dividends (and/or total market cap divided by GDP) with some other math thrown in.  And while I found his total return calculation for the SP500 to be understated (or perhaps I made a mistake in how I calculated "avg 10 year total return") the overall directionality of the charts matched with mine.  That means - if the projection said "the next 10 years will be good", the market (more or less) did well for 10 years.  There was also an easy to see cyclicality - an alternating "decades of feast" followed by "decades of famine."

This is all stuff that Robert Shiller has done (among others) - but its the first time I've actually sat down and gone over the numbers and really understood it all in the context of Chris's "next 20 years" thinking.

Under current projections, the 10-year projected nominal return on the equity markets looking forward (2013-2023) will be about 3% per year.  Relatively speaking: a decade of famine.  As a basis for comparison, during the 80s-90s, the projection was about 10-20%.   During the 1980-2000 period, you couldn't avoid making at least 10% per year if you just picked a basket of stocks.  That's what the projection said would happen, and that's what happened - that, and more.  But if you bought in 2000, you'd lose money over 10 years.  That's what the projections showed, and that's more or less what happened.  We apparently have another 10 of these years coming up.

A couple of things struck me really hard.  These cycles run for 20-30 years.  If you buy in at the high point in the cycle, don't expect much of a return for your risk.  What's more, given market volatility, sticking out 20-30% equity market drops in order to get a 3% annual return is most definitely picking up nickels in front of the steamroller - its extremely difficult to sit by and take a 30% loss.  That's where we are now.  The next 10 years will be a constant steamroller.  Same thing Chris has been saying, but Hussman's model doesn't assume any fundamental changes in the growth picture, while Chris does.  This distinction is important.

If we buy in to the story laid out by Chris - that we are at the tag end of a 40 year credit bubble, that energy production is no longer growing at 3% per year, that many things have peaked, and demographics tell us we'll have fewer workers and more retirees, we are concerned with how the future will look.  Yet baked into John Hussman's projections of the anemic 3% ROI is - the assumption that the economy will continue to grow at the old baseline of 3% per year.

Bottom line: Hussman's projections of market "famine" returns that are based on the growth story remaining intact says we're at the top of the cycle.  That things are expensive right now just when viewed under the old paradigm!  How scary is that?

One other point he made that I agree with completely: current market prices are being justified by high corporate earnings.  Our "levitating markets" have been driven by a reach for yield (driven by 0% rates engineered by the Fed) and high earnings driven by unsustainable government deficit spending.

This shows up in corporate earnings that are at historically high levels - about 11% of GDP.  Over the long term, corporate profits average 6% of GDP.  If PE ratios and dividends follow a reversion to the mean, this one thing alone would drag the market down perhaps 50%!!  If and when the deficit drops (unsustainable things must end at some point) he feels those profits will vanish also.  (If we presume there is no resumption of the debt bubble, I think his assumption is correct)

To summarize, I see the current equity market now as picking up pennies in front of steamrollers.  Chris has been saying this as well.  The tricky part, however, is always the timing.  Its hard to make money on the short side using a 20 year macro view unless you are very patient and you have excellent timing, and even then with our system's built-in inflationary bias and *everyone's* desire to see things go up, going short is swimming against the tide in a major way.

Perhaps at the end of the day, my takeaway from Hussman's talk is primarily about preparing my own mind-set and expectations as to what returns I can expect to see over the next 10 year period.  The implications of difficult times ahead is nothing new to people here, yet when an optimistic model predicts a decade of market famine based on underlying expectations of the 3% growth model remaining intact, its quite a sobering thing to me.

 

SingleSpeak's picture
SingleSpeak
Status: Platinum Member (Offline)
Joined: Dec 1 2008
Posts: 505
More Buyers Than Sellers

While it is true that there cannot be "more buyers than sellers" as the end result of a trading day or trading period, what I believe is meant or implied by saying, "There were more buyers than sellers so the price went up today", is that "There were more buyers willing to buy at or below yesterday's price than sellers willing to sell at or below yesterday's price, therefore in order to reach equillibrium the price went up."
Now, that should satisify Mr. Hussman, but it ain't gonna happen. Therefore, just as I have managed to get over my dismay when I hear the misstatement, "I could care less," when a person actually means, "I couldn't care less," Mr. Hussman will manage to get over the "more buyers than sellers" error.

davefairtex said

.... The implications of difficult times ahead is nothing new to people here, yet when an optimistic model predicts a decade of market famine based on underlying expectations of the 3% growth model remaining intact, its quite a sobering thing to me.

 

Ditto.

SS

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