Things I Believe by John P. Hussman, Ph.D.
1) Investors dangerously underestimate the risk of an abrupt and possibly severe equity market plunge
Look back over history at points in time where stocks were trading at a rich multiple to normalized earnings (the Shiller multiple is a useful gauge here, as forward operating and price/peak earnings are both corrupted by profit margins that are about 50% above their historic norms). Combine that with overbought, overbullish conditions and rising interest rates. What you will get is a list of most historical pre-crash peaks. Depending on precisely how you define your classifier, you may pick up one or two benign outcomes, such as April 1999 (which I noted in the Hazardous Ovoboby piece in early 2007), but ask whether, on average, you would have knowingly chosen to take market risk at those points.
2) Agreement among "experts" is not your friend
“Tarnished! Nobody expects gold prices to turn up soon: It’s difficult to find any positive news in the depressed gold market. At around $260 an ounce, the metal continues to trade near its cost of production, and almost no one believes it will rally soon. ‘Financing is tough to come by these days’ in the unpopular gold-mining sector, says Ferdi Dippenaar, Harmony’s director of marketing. ‘Unfortunately, there is nothing positive on the horizon.’”
Barron’s Magazine, Commodities Corner: February 12, 2001
"Not a Bear Among Them"
Barron’s Investment Roundtable, December 1972 (at the beginning of a 50% market plunge – No intent to pick on Barron’s – they’ve just been around the longest, so we have lots of back-issues)
"Wall Street Heavyweights Agree: Time to Get Back Into Stocks!"
USA Today Investment Roundtable, December 2010
3) Downside risk tends to be elevated precisely when risk premiums and volatility indices reflect the most complacency
I could go on, but nobody cares.
4) We did not avoid a second Great Depression because we bailed out financial institutions. Rather, the collapse in the economy and the surge in unemployment were the direct result of a gaping hole in the U.S. regulatory structure that prevented the rapid restructuring of insolvent non-bank financials. Policy makers then inappropriately extended the "too big to fail" doctrine to ordinary banks. Following a striking loss of public confidence that resulted from arbitrary policy responses, coupled with fear-mongering by exactly those who stood to benefit from public handouts, the self-fulfilling crisis was contained by a change in accounting rules that effectively disabled capital requirements for all financial companies. We are now left with a Ponzi scheme.
More here: Hussman Funds – Weekly Market Comment: Things I Believe – December 20, 2010.
