While we don’t presently observe conditions to indicate a ‘buying opportunity’ or a ‘bottom’ from a full-cycle standpoint, we do observe conditions that are permissive of a scorching market rebound, even if it only turns out to be the ‘fast, furious, prone to failure’ variety. I say ‘permissive’ because there is no certainty about a rebound, and we wouldn’t dream of removing our safety nets against a market decline that I continue to expect to draw the S&P 500 toward the 1000 level by the completion of this cycle. Still, we’ve prepared for the possibility of unusual volatility here, most likely including one or more daily moves in the range of 4-6%, potentially to the upside. Yes, that means one or more daily moves on the order of 100-150 points on the S&P 500 and 900-1300 points on the Dow. You think I’m kidding.
– John P. Hussman, Ph.D., December 26, 2018 (pre-open)
Three considerations: valuations, internals, and overextension
At the market close on Friday February 28, the cumulative total return of the S&P 500 Index, since its September 20, 2018 pre-correction peak, stood just 0.61% ahead of the total return on risk-free 3-month Treasury bills for the same period. Everything else – the market correction in the fourth quarter of 2018, the 2019 market advance, the speculative run to record highs in mid-February, and last week’s “trap door” market plunge – has essentially been a long, volatile trip to nowhere. Risk-aversion wreaks havoc on a market that’s priced for zero risk.
From a full-cycle perspective, the decline in the U.S. stock market from its recent high remains something of a non-event, compared with the probable market loss over the completion of this cycle.
I continue to expect the S&P 500 to lose about two-thirds of its value from its recent high to the trough of the next bear market. As I’ve regularly observed, a decline of that magnitude would not be a worst-case scenario. Rather, it would merely draw S&P 500 valuations to historically run-of-the-mill valuation norms that have been observed over the completion of nearly every market cycle in history, with the exception of the 2002 low (which was later breached in 2009). Based on the valuation measures we find best-correlated with actual subsequent market returns across history, even a retreat to October 2002 valuations would require a market loss of over -50% from the recent peak.
To put run-of-the-mill historical valuation norms into perspective, a two-thirds loss in the S&P 500 Index from its February 19 high of 3386 would place the index at roughly 1129, still about -62% below where the index closed at the end of last week.
A detailed discussion of our full-cycle concerns, as well as a review of broad market conditions, is provided in my February 25 comment Make Good Choices!.