Author: John P. Hussman, PhD

As of last week, the S&P 500 was priced to achieve an average annual total return of just 5.83% over the coming decade, based on our standard methodology. Prior to 1995, the lowest implied 10-year total returns priced into the S&P 500 in post-war data were:

November 1961: Implied 10-year total return 6.26%.
Actual 10-year subsequent return 6.16%

October 1965: Implied 10-year total return 5.89%.
Actual 10-year subsequent return 3.11%

November 1968: Implied 10-year total return 6.19%.
Actual 10-year subsequent return 2.51%

August 1987: Implied 10-year total return 6.29%.
Actual 10-year subsequent return 13.85%.

Note that in the 1987 case, the unusually strong 10-year return reflects a move to the extreme bubble valuations in the late 1990’s, which have in turn been followed by 13 years of market returns below Treasury bill yields. Once the market becomes overvalued, further gains are ultimately paid for by a period of sorry returns later. To expect normal or above-average long-term returns from current prices is to rely on the market bailing out the rich overvaluation of today with extreme bubble valuations down the road.

While investors can hope that today is similar to August 1987, a moment’s reflection about the market crash that occurred shortly after August 1987 might dampen that hope a bit, particularly because that instance also featured overbought, overbullish and rising-yield conditions.

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See Also:

• And Now Let Us Analyze Likely Long-Term Stock Returns
• THE GREAT DISCONNECT: Stocks 30% Overvalued And Still Going Up… And Housing Rolling Over
• Hussman: I’m Not Saying There’s Going To Be Hyperinflation, But INFLATION IS GOING TO BE HUGE

“The best way to destroy the capitalist system is to debauch the currency.”

Vladimir Lenin, leader of the 1917 Russian Revolution

Last week, while Congress and the nation were preoccupied with the holidays, the Treasury made a Christmas eve announcement that it would be providing Fannie Mae and Freddie Mac unlimited financial support for the next three years. The Treasury’s press release notes:

“At the time the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship in September 2008, Treasury established Preferred Stock Purchase Agreements (PSPAs) to ensure that each firm maintained a positive net worth. Treasury is now amending the PSPAs to allow the cap on Treasury’s funding commitment under these agreements to increase as necessary to accommodate any cumulative reduction in net worth over the next three years.”

Put simply, in a single, coordinated stroke, the Treasury and the Federal Reserve have encroached on spending powers that are enumerated for the Congress alone. Under the Housing and Economic Recovery Act of 2008 (HERA), the Treasury has no such open-ended authority. Indeed, the applicable portion of the Act explicitly limits the total amount of mortgage principal (not losses, but total principal) as follows:

“LIMITATION ON AGGREGATE INSURANCE AUTHORITY.—The aggregate original principal obligation of all mortgages insured under this section may not exceed $300,000,000,000.”

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See Also:

• Hussman: Stocks Are "Decidedly" Speculative At These Levels
• Relax About The Fannie And Freddie Bailouts, They’re Just In The Same Business As The Fed
• Fannie Mae: Delinquencies Increase Sharply in October

The following is an excerpt from fund manager John Hussman’s weekly letter.  You can read the whole thing here.

I noted last week that from a Bayesian perspective, I would estimate a probability of nearly 80% that we will observe a second round of credit losses coupled with a market plunge in the coming year or so. That doesn’t imply an all-out “crash,” but more likely a retreat similar in size to what we have often observed following other post-crash rebounds (about -28% on average).

Of course, from the standpoint of compounding, a 28% decline converts a 60% gain to a more modest 15% net advance, so even without an outright “crash,” it would not be surprising to see the majority of the gains since the March low wiped out. Most likely, we may see a few more years of sideways movement after that, as the economy absorbs the full weight of adjustment to the deleveraging of bad debt and massive increase in government liabilities that we have on our hands.

Suffice it to say that I do not anticipate a V-shaped recovery, and while the stock market may very well recover faster than the rest of the economy, I don’t expect durable market gains until after the second wave of losses shakes out.

On the subject of credit delinquencies, the latest report by Trepp (which provides independent research on commercial mortgage-backed securities) indicates that delinquencies on multifamily CMBS loans rose to 8.78 percent in November, up from 7.66 percent the previous month. Commercial delinquencies in retail, industrial and office loans increased as well. The largest jump in delinquencies was in the hotel sector, where the delinquency rate shot to 14.09 percent, from 8.67 percent in October. The data from the banking sector also shows no abatement…

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See Also:

• Hussman: 80% Chance Of A Market Crash Over The Next Year
• Hussman: I Was Wrong, And Didn’t Realize How Stupid Investors Were
• Hussman: Beware The Oncoming Tanks