John Hussman On Market Mean-Reversion

Adam Taggart
By Adam Taggart on Tue, May 27, 2014 - 6:38pm

Here is the excellent presentation John Hussman gave at the 2014 Wine Country Conference in Sonoma, CA.

John is an exceptionally quantitative scholar of the markets, which is apparent in spades in this presentation. He shows some very powerful charts here, which in essence say: if you believe in math, if you believe in reversion to the mean, then today's financial markets are dizzyingly overpriced:

We remain in agreement with John that bubble markets like today's force investors to either look like idiots today (by sitting on the sidelines) or look like ones tomorrow (by riding the bubble until it pops disastrously). We're comfortable with the former.

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16 Comments

Rector's picture
Rector
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Oh.

I just hideous regression analysis flashbacks to business school.  You should have warned us about that.  The sum of a log is the product. . .I accept the conclusion.  

pyranablade's picture
pyranablade
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The lack of comments might mean

Maybe if a lot of people understood the video they would comment on it.

Some of us did have statistics in college, but maybe it wasn't business statistics. I propose that somebody who understands the underlying math and the underlying economics of this presentation would paraphrase it for the rest of us...dumb it down as needed. Some things may get lost in the translation, but at least the whole video won't be posted in vain.

 

KugsCheese's picture
KugsCheese
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Re: The lack of comments might mean

Hussman explains his basic point at ~12:20.  And the assumption is human actions in the aggregate like a stock market or the economy will act like all natural phenomenon: growth has to correct (e.g. death). 

pyranablade's picture
pyranablade
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Thanks Kugs

Kugs, sounds more pessimistic than the Law of Entropy that John Michael Greer talks about. So everything will go back to zero?

KugsCheese's picture
KugsCheese
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The problem I have even with

The problem I have even with these stats is that the time period is too short.  The FED since 1971 has so distorted the money rate and dependent markets that outliers are more probable now.  So there is a very real chance that such a crash could come that wipes out returns for 30 years or more, think Dark Ages type disruption.

robie robinson's picture
robie robinson
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zero may be aproached

but it will never be realized...did i just make an absolute statement about absolutely nothing?

cmartenson's picture
cmartenson
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And the problem I have...
KugsCheese wrote:

The problem I have even with these stats is that the time period is too short.  The FED since 1971 has so distorted the money rate and dependent markets that outliers are more probable now.  So there is a very real chance that such a crash could come that wipes out returns for 30 years or more, think Dark Ages type disruption.

And the problem I have...is that all the historical ratios we come to expect to be mean-reverted to were formed during a period of intense fossil fuel extraction.

During nearly the entire time-series net energy was rising.  It is now nosing over and will someday go in reverse.

What do any historical relationships between earnings and prices mean when net energy is declining?

Not a lot, is my view.

There's going to be a whole slew of new ratios and relationships worked out over time, but the idea that the markers for wealth (stock values, debt instruments, and currency) can just continually grow exponentially while net energy declines is simply an unworkable proposition to me.

davefairtex's picture
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amen brother

Chris-

And the problem I have...is that all the historical ratios we come to expect to be mean-reverted to were formed during a period of intense fossil fuel extraction.

Yeah.  I feel exactly the same way.  After studying Hussman's basic formula - the thing he bases all of his analysis on - there's one little assumed number in there that drives everything, and that's the assumption of an annual 6.3% nominal growth year over year.  Its an underlying assumption that was developed under the century-long regime of our using up all those fossil fuels.  Historically he's right to use this number; he didn't pick it by accident.  He's a very careful guy.

And since he's super-smart, he likely knows about this very issue of this built-in assumption possibly being wildly optimistic going forward.  His bread-and-butter talk looks forward 10 years - the 10-year expected return.  If in the next 10 years, we hit peak non-cheap oil - and more importantly the implications of that become widely accepted - that 6.3% will vanish and it will turn into a built-in negative number!

I shudder to think what that will do to those expected 10 year return charts.

I wonder if he's done that yet.  Dropping in a negative number in place of that 6.3%.

Or heck.  Just putting in 0% and seeing what THAT does.

Without some sort of Arthur(ian) Deux Ex Machina from LENR, the repricing we experience - over the long term - will be the stuff of legend.

Anyhow...back to my charts.  :-)

aggrivated's picture
aggrivated
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What I heard.

When it comes to the statistical part he might as well have been speaking ancient Persian. What I carried out from the conclusions drawn--sit in cash or an alternative and wait for a better opportunity to buy any stocks.  The Fed has brought future earnings into today's timeframe with its policies. To buy at today's prices is to buy high and sell low. 

Arthur Robey's picture
Arthur Robey
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Pariah Messiah.

Without some sort of Arthur(ian) Deux Ex Machina from LENR, the repricing we experience - over the long term - will be the stuff of legend.

I live in hope that we can have one more bite of the cherry to get our house in order.

My role is not to hear the penny drop but to fling it violently onto our proverbial foot.

But our lessons are always hard won. The lesson will be the failure of industrial agriculture. That should do quite nicely to wake the few survivors. "Oh, Now I understand."

 

aggrivated's picture
aggrivated
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a penny flung

I'm reading Ugo Bardi's "Extracted" right now.  He points out in the historical section that when the Romans couldn't pay soldiers in precious metals any longer due to exhaustion of the mines, they eventually started giving out land grants.  This was a nice foundation for the medieval serf system.  We will continue to have a contraction-after the bubble bursts from a lack of black gold.  Where will that take us.

Any thoughts on future economic opportunities?  Tennessee Earnie Ford's '16 tons' comes to my mind.--but then I guess we're already 99% there on owing the 'company store' front.  Maybe Sanford and Son would be a good approach, or better yet, own a city dump and start mining it for precious resources.

jgritter's picture
jgritter
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Elephant

So the take away is what goes up must come down.  6.3% mean annual gains on the up side of Hubbard's curve would seem to suggest 6.3%mean annual declines on the down side.  Given the apparent numbers for declining automobile sales and gasoline use is it fair to say that we are over the top of the curve or is that still just signal noise?  Also, since it seems that resource exploitation curves seem to be symmetrical, is it fair to say that we may have decades before the economy truly drops into free fall recognizing that there could be some very ugly shocks before the bottom drops out completely.

I'm sorry, I'm struggling with the idea that an exponential increase in population must inevitable be followed by and exponential decrease in population.  It would seem to be the elephant in the room.

John G.

KugsCheese's picture
KugsCheese
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Is Nature Zero Sum?

If I was an alien looking, listening at Earth, I would conclude this: the human animal used stored fossil fuels to enhance human wealth.  So Natural Wealth was traded for Human Wealth.  Zero Sum.   If fossil fuels are now exhausted, this alien sees that all the assumptions built up over the last 100 years are invalid.  If the assumptions are invalid, all the recent economic arguing with statistics is invalid.   This is where the genius of markets comes to help determine a future that is vastly different.  Unfortunately, the elites are doing their best to continue invalid assumptions thus distorting markets to the point of fantasy. 

aggrivated's picture
aggrivated
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the elephant in the room

In the past history of humanity hunger, wars and disease were the primary limits on growth of population.  Is there an indication that any combination of these won't be in play on future growth limits?  I don't think the elephant is all that well hidden, and besides, like the dinosaurs, elephants don't live without large and undisturbed habitats.  The population explosion is along with many other appearances of permanence, an artifice of easy excess energy. It cannot survive without it.

alfrede's picture
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Chris & Dave's points
davefairtex wrote:

Chris-

And the problem I have...is that all the historical ratios we come to expect to be mean-reverted to were formed during a period of intense fossil fuel extraction.

Yeah.  I feel exactly the same way.  After studying Hussman's basic formula - the thing he bases all of his analysis on - there's one little assumed number in there that drives everything, and that's the assumption of an annual 6.3% nominal growth year over year.  Its an underlying assumption that was developed under the century-long regime of our using up all those fossil fuels.  Historically he's right to use this number; he didn't pick it by accident.  He's a very careful guy.

And since he's super-smart, he likely knows about this very issue of this built-in assumption possibly being wildly optimistic going forward.  His bread-and-butter talk looks forward 10 years - the 10-year expected return.  If in the next 10 years, we hit peak non-cheap oil - and more importantly the implications of that become widely accepted - that 6.3% will vanish and it will turn into a built-in negative number!

 

Orlov and Bates reports from The Age of Limits Conference; that  Dennis Meadows contented that their Club of Rome models are not to be relied upon once peaks/limits are reached seems to me to be making the very same point.

cluborlov.blogspot.com

peaksurfer.blogspot.com

 

 

davefairtex's picture
davefairtex
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elephants in rooms

jgritter-

In looking back in the US census data, I saw that from 1930-1939 the birthrate in the US dropped from a 1.5-1.8% annual increase down to a 0.6% annual increase.

You can see similar things in Japan during their 20 year "lost two decades."  Economic problems seems to result in substantially lower birth rates.  My guess is this will be exacerbated if and when -6.3% per year is seen as baked into the cake rather than just some more temporary period of adjustment like the depression.

https://www.census.gov/popest/data/national/totals/pre-1980/tables/popclockest.txt

I am sure that mitigation strategies, once we actually start to employ them, will assist in reducing the impact of the -6.3% reduction - and also note that 6.3% number is a nominal number (i.e. not inflation-adjusted) rather than a "real number."  In other words, some chunk of that 6.3% is due to money growth, not real growth.

However, if we assume a deflationary experience, a nominal -6.3% may well reflect the deflation inherent in the period.  Its an interesting thought.  Our current money system will definitely have issues during this time.  No doubt we'll have to evolve a new system.

I've mentioned this before - I could easily see a time in the not-so-distant future that gold mines are simply shut down as a "waste of society's scarce resources" during a time of declining energy.  Picture the US during WW2 and how rationing was used to retain resources for things deemed important for the war effort.

That would no doubt be bullish for gold - bars & coins, I mean.  Not so good for the junior miners, however!

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