Nowadays, when I find myself feeling too good about things I read fund manager John Hussman’s weekly column and it brings me back to Earth. He may be off on the timing but it’s difficult to dispute his main argument that we’re in the late stages of a massive speculative bubble fueled by easy credit and other unwise govt policies.
There’s fraying at the edges in junk bonds and much nervous volatility in stocks, where successive sectors have inflated and then deflated since early 2015. Everyone knows we are due for a market debacle but no one knows when. It could happen in two days or two years. Meanwhile everyone stays invested because what else can you do with your money (answer: keep it in cash, but that’s hard to do until it’s too late) and maybe you can make some profits before the bottom falls out…
From his latest missive:
Over the past several years, yield-seeking investors, starved for any “pickup” in yield over Treasury securities, have piled into the junk debt and leveraged loan markets. Just as equity valuations have been driven to the second most extreme point in history (and the single most extreme point in history for the median stock, where valuations are well-beyond 2000 levels), risk premiums on speculative debt were compressed to razor-thin levels. By 2014, the spread between junk bond yields and Treasury yields had fallen to less than 2.4%. Since then, years of expected “risk-premiums” have been erased by capital losses, and defaults haven’t even spiked yet (they do so with a lag).
From an economic standpoint, the unfortunate fact is that the proceeds from aggressive issuance of junk debt and leveraged loans in the past few years were channeled into speculation. Excess capacity in energy production was expanded at the cyclical peak in oil prices, and heavy stock buybacks were executed at obscene equity valuations. The end result will be unintended wealth transfers and deadweight losses for the economy. Since the late-1990’s, the Federal Reserve has actively encouraged the channeling of trillions of dollars of savings into speculation. Recurring cycles of malinvestment and crisis have progressively weakened the resilience and long-term growth prospects of the U.S. economy.
[. . .]
Our outlook remains decidedly negative at present. I’ll emphasize again that market internals are the hinge that distinguishes a valuation bubble that expands from one that collapses, so an improvement in market internals would reduce the immediacy of our downside concerns, and would also tend to reduce our concerns about oncoming recession. In the absence of clear improvement in market internals – and last week was categorically opposite to that – I view the stock market as being in the late-phase of an extremely overvalued top formation that will likely be followed by profound losses over the completion of this market cycle, and the U.S. economy as being on the cusp of a new recession.
Interesting times ahead.
