Hussman Weekly Market Comment: Distinction Without a Difference

The difficulty today is not only that valuations are rich, but that on our metrics, present market conditions cluster among those that have produced strikingly negative market outcomes on a blended horizon from 2-weeks to 18-months. Wall Street’s beloved forward-earnings multiples only seem reasonable here because profit margins are the highest in history (largely as a result of steep government deficits and depressed savings rates). Once we normalize for profit margins – which is necessary because stocks are very long-lived assets – valuations are elevated, and are coupled with a variety of historically hostile, overvalued, overbought indicator syndromes. Moreover, while our economic concerns do not significantly feed into our concerns about the equity market, we continue to view the U.S. economy as being in an unrecognized recession that started about mid-year.

Recession? The advance estimate for third-quarter GDP was released last week, showing a slow but above-consensus figure of 2% growth at an annual rate (paced by a 13% surge in defense spending). Surely, this is inconsistent with concerns about recession, isn’t it? No – not if we examine the historical pattern of data revisions early in previous recessions – a point that Lakshman Achuthan of ECRI also emphasized recently on Bloomberg.

Recall that in 2001, with the U.S. economy already in recession for months, Q1 GDP growth was initially reported at 1.2%. That figure was actually revised slightly higher a few months later, but based on final revision, Q1 2001 GDP is now reported at -1.3%. As a side-note, Q2 2001 GDP was positive, while Q3 2001 was negative. The 2001 recession did not contain two consecutive quarters of negative GDP growth. Contrary to what many analysts suggest, that is not how the National Bureau of Economic Research (the official arbiter) defines a recession in the first place.

The heavy revision of GDP figures is not the exception but the rule. In the first quarter of 2008, as another example, with the U.S. economy already in recession for three months, Q1 GDP was reported at 1% growth. That figure was later revised to -1.8%. Just like 2001, the following quarter was reported at positive growth. The economy then collapsed in the second half of 2008, but by the time that was evident in GDP figures, the stock market had already plunged. The upshot is that early GDP figures are often reported positive even after a recession is already well in progress, and waiting for two consecutive quarterly declines in GDP is a poor way of gauging recession risk, because that pattern sometimes doesn’t emerge until much later revision, if at all.