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While investors are talking about themselves, and possibly the Federal Reserve, for another rate cut, stock markets have the feeling that more prosperous times are ahead.
This could mean new records in the main indices. After all, when Fed Chairman Jerome Powell hinted last week that new monetary easing measures could be considered, equities have risen. They ended up shooting in their best week of 2019 to date.
John Hussman, the former professor of economics who is currently president of the Hussman Investment Trust, is not here to dispel this idea. However, he believes that taking more risks in the Fed's mind would be a big mistake for investors and for the wider market.
His argument boils down to a crucial misunderstanding that he believes gives traders false hope: the idea that lower interest rates justify higher valuations of equities.
Hussman admits that this is true during periods when cash flows are either stationary or growing. But he also insisted that this is not one of those moments. In his mind, keeping up with the idea that rate cuts will save the market is a mistake.
"The problem is that if interest rates are low because growth is also low, low interest rates do not warrant any increase in valuation multiples," wrote Hussman in a recent article on his blog.
He continued: "While Wall Street mechanically recited the aphorism that" lower interest rates justify higher valuation multiples ", this proposal is valid. only if the trajectory of future cash flows is kept constant. "
Hussman goes further and exposes a totally plausible – and scary – scenario. He says that if inflation stays around 2%, business revenue growth will be only 3.5%. Then, if there is no "persistent expansion" in margins, the earnings expansion will also reach about 3.5% per year.
"Even the slightest decline in valuation multiples will likely produce a multi-year period of negative total returns for the S & P 500," he said. "All this is only basic arithmetic."
This is due to Hussman's long-standing claim that US stocks could experience a sharp drop in the lineage of a 60% to 65% drop. He also predicted that the S & P 500's total return would be around zero over the next 12 years.
However, there remains a question: what will happen if and when the Fed will actually reduce its rates, since it seems that they could do it by June?
Hussman says it depends on the market's appetite for risk. Of course, investors are feeling refreshed right now, but once they've switched the switch to worry mode, he said things could collapse quickly. That's right, even the precious Fed will not be able to save the market.
"When investors are inclined to risk aversion, secure low-interest liquidity is a preferred badet and not a lower badet," said Hussman. "So, creating more things does not do anything to encourage more speculation."
"When we remember that the US Federal Reserve has softened persistently and aggressively throughout the collapses of 2000-2002 and 2007-2009, it should be clear very brief reaction of the knee reflex".
The road map of Hussman
For the uninitiated, Hussman has made headlines by predicting a stock market downturn of more than 60% and anticipating a full decade of negative equity returns. And as the stock market continued to climb for the most part, he persisted in his appeals without getting discouraged.
But before dismissing Hussman as insightful, look at his record, which he breaks down in his latest blog post. Here are the arguments that he states:
- Expected in March 2000 that technology stocks would plummet by 83%, the Nasdaq 100 index, highly technology – driven, would lose 83% "of improbable accuracy" between 2000 and 2002.
- Expected in 2000 that the S & P 500 would likely have negative total returns over the next decade, which was the case
- Scheduled in April 2007 that the S & P 500 could lose 40%, then 55% during the collapse from 2007 to 2009
In the end, the more Hussman discovers that the unsustainable conditions of the stock market are revealed, the more investors should be worried. Of course, there may still be returns to be made in this market cycle, but at what point does the increasing risk of an accident become too unbearable?
This is a question to which investors will have to answer themselves. And it's a Hussman that will continue to explore in the meantime.
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