Courtesy of Mish.
I received an email a few weeks ago stating "Hussman has been so wrong I should stop quoting him."
Nonetheless here I go again, because I think Hussman has something important to say. Please consider a few admittedly lengthy snips from his post today Pills for Cognitive Dissonance in a Speculative Bubble.
Several years of persistent yield-seeking speculation provoked by zero-interest rate monetary policies have created a fertile ground for cognitive dissonance. On one hand, any observer with historical perspective knows not only that the overvaluation from this kind of speculation inevitably ends in tears, but also that the heavy issuance of new speculative and low-quality securities during the bubble finances and enables unproductive malinvestment that leaves the economy far worse off in the end. On the other hand, prices have been advancing.
It’s difficult to entertain both of those facts at once. One must simultaneously hold in mind reckless yield-seeking speculation, hypervaluation that rivals the 1929 and 2000 equity market peaks (see Yes, This is an Equity Bubble), zero interest rates, low prospective long-term returns all around, and persistent malinvestment that poses increasing systemic risks for the entire global economy, plus one fact that encourages us to forget it all: prices have been going up. Cognitive dissonance tempts us to reconcile this tension by ignoring one part of the story or another.
[From Yes, This is an Equity Bubble]
One would think the Federal Reserve would have learned from that catastrophe. Instead, the Fed has spent the past several years intentionally trying to revive the precise dynamic that produced it. As a consequence, speculative yield-seeking has now driven the most historically reliable measures of equity valuation to more than double their pre-bubble norms. Meanwhile, as investors reach for yield in lower-quality but higher-yielding debt securities, leveraged loan volume (loans to already highly indebted borrowers) has reached record highs, with the majority of that debt as “covenant lite” issuance that lacks traditional protections in the event of default. Junk bond issuance is also at a record high. Moreover, all of this issuance is interconnected, as one of the primary uses of new debt issuance is to finance the purchase of equities.
At present, the most historically reliable valuation measures are more than 100% above pre-bubble historical norms. Investors who dismiss present market valuations by reflexively parroting the phrase “lower interest rates justify higher valuations” haven’t thought carefully about the problem or done the math, and that math is just basic arithmetic.
Make no mistake – this is an equity bubble, and a highly advanced one. On the most historically reliable measures, it is easily beyond 1972 and 1987, beyond 1929 and 2007, and is now within about 15% of the 2000 extreme. The main difference between the current episode and that of 2000 is that the 2000 bubble was strikingly obvious in technology, whereas the present one is diffused across all sectors in a way that makes valuations for most stocks actually worse than in 2000.
[End Yes, This is an Equity Bubble – Back to Cognitive Dissonance]
Red Pill, Blue Pill
Probably the most interesting response to the cognitive dissonance provoked by the present yield-seeking mania comes from Hugh Hendry at Eclectica (h/t ZeroHedge) who quite clearly recognizes the repulsive long-term situation, but has embraced central-bank induced speculation out of the necessity of self-preservation as a money manager. I would actually agree with him here were it not for the fact that the behavior of market internals and credit spreads doesn’t really recommend an outlook tied to the world of illusion. That may change, and if it does, it would admit a greater range of investment outlooks in the category of “constructive with a safety net.” Hendry’s own struggle with the cognitive dissonance of this period is evident:
“There are times when an investor has no choice but to behave as though he believes in things that don’t necessarily exist. For us, that means being willing to be long risk assets in the full knowledge of two things: that those assets may have no qualitative support; and second, that this is all going to end painfully. The good news is that mankind clearly has the ability to suspend rational judgment long and often."
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Picture by W.Carter at Wikimedia.
