The Hussman Report

Lessons From a Lost Decade

John P. Hussman, Ph.D.

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Reprint Policy

Over the past decade, stock market investors have experienced enormous volatility, including two separate market declines in excess of 50%. Despite periodic advances, at the end of it all, as a reward for their patience, investors have achieved an average annual total return of approximately zero... Put simply, greater risk does not imply greater reward if the risks that investors take are overvalued and inefficient ones.

The second lesson is that the effects of wasteful misallocation of capital cannot be fixed by policies that encourage the wasteful misallocation of capital. Fortunately or unfortunately, policies can often help to prop up unsustainable patterns of activity in order to "kick the can down the road." This can postpone major economic adjustments, but often makes the ultimate adjustment even worse.

Over the short run, two policies have been primarily responsible for successfully kicking the can down the road following the recent financial crisis. The first was the suppression of fair and accurate financial disclosure - specifically FASB suspension of mark-to-market rules - which has allowed financial companies to present balance sheets that are detached from any need to reflect the actual liquidating value of their assets. The second was the de facto grant of the government's full faith and credit to Fannie Mae and Freddie Mac securities. Now, since standing behind insolvent debt in order to make it whole is strictly an act of fiscal policy, one would think that under the Constitution, it would have been subject to Congressional debate and democratic process. But the Bernanke Fed evidently views democracy as a clumsy extravagance, and so, the Fed accumulated $1.5 trillion in the debt obligations of these insolvent agencies, which effectively forces the public to make those obligations whole, without any actual need for public input on the matter.

Market Climate

As of last week, the Market Climate for stocks was characterized by strenuous overvaluation, overbought price action, overbullish sentiment, and a shift to neutral though not yet rising yield pressures. The Investors Intelligence data shows a significant shift from the "correction" camp to the bullish camp among investment advisors, with 45.6% bulls and 24.4% bears. The more volatile American Association of Individual Investors poll shows an even wider skew, with 51.6% bulls and just 21.6% bears. 

http://www.hussman.net/wmc/wmc101101.htm