Two Lost Decades

Fundamentally, the S&P 500 can easily fall to 500 or below, a massive crash from this point. Alternatively, stocks might languish for years.

click on chart for sharper image

The Japanese Stock Market is about 25% of what it was close to 20 years ago! Yes, I know, the US is not Japan, that deflation can’t happen here, etc, etc. Of course deflation did happen here, so the question now is how long it lasts.

Bulls Dance On Edge Of Cliff

It’s time to review Hussman on Valuation; Stocks Higher? Bulls Dance On Edge Of Cliff

John Hussman:

It’s important to recognize that when I quote probabilities, I am generally using a form of Bayes’ Rule. So when I say, for example, that I estimate a probability of about 80% of fresh credit difficulties accompanied by a market plunge over the coming year, that figure is based on various combinations of historical evidence, and what has (and has not) happened afterward, and how often. As a side note, a “market plunge” in this context need not be a “crash.” In the context of a credit-driven crash and rebound (which is what I believe we’ve observed), a typical post-rebound correction would be about -28%, but even that would take stocks to less than 20% above the March lows.

That was Hussman’s view. I think the probabilities look something like this:

* 20% chance of a durable rally
* 20% chance the market meanders nowhere for as long as 5 years
* 30% chance of of a hard 25-30% correction
* 30% chance the bottom is not even in

Unlike Hussman, I have not done any statistical analysis of my estimates. Certainly his “estimate a probability of about 80% of fresh credit difficulties accompanied by a market plunge over the coming year” is reasonable enough.

[Note: those probabilities were written in December. The odds of a strong rally now, are less likely, perhaps 10-15% at best]

Note that Hussman’s 80% probability of a plunge encompasses a plunge where the bottom holds and also where it doesn’t.

The key for me is that on average it does not pay to be fully invested here, regardless of what the stampede of bulls say. Bear in mind, the bulls were saying exactly the same thing as they are now right at the October 2007 high. I received taunts for several months for my market top call late summer of 2007, about 3% and 3 months early.

Is the top in now? No one knows, but that is not even the right question to be asking. A far better question to be asking is “Is the bottom in?” Even if it is, a major test coming of that bottom down the road is highly likely and that will gore a lot of overly complacent bulls along the way.

Fundamental Thesis

The odds of another huge stock market dip in 2010 or 2011 are huge. The odds of another recession in the next 10 years are also huge. Heck, the odds of double-dip recession in 2010 or 2011 are very substantial.

Fundamentally, a huge wave of boomer retirement is coming up, and those retirees will be drawing down funds and lowering lifestyles, not contributing and consuming more. Moreover, global wage arbitrage still has not played out and there is huge downward pressure on wages and jobs.

Credit card defaults are still soaring, and banks are still sitting in hundreds of billions of dollars worth of assets held off the balance sheet. The S&P PE is over 20, a number associated with market tops, not bottoms.

Structurally, unemployment will remain high for a decade. And finally, consumer attitudes towards debt and risk have reached a secular peak and have turned.

That is not a backdrop for a huge bull market in equities or a massive bet on inflation either.

Pension plans better figure this out and act accordingly or they are going to dig themselves an even deeper hole.

I definitely dont see a range-bound market, unless the range is 2000-4000 on the Dow.