Hussman Weekly Market Comment: Two Myths and a Legend

In late-2008, with the S&P 500 down 40%, I noted that stocks had become reasonably valued (see Why Warren Buffett is Right, and Why Nobody Cares). The coupling of improved valuations with an early improvement in market action – at least on post-war measures – was a fairly standard combination of events warranting a constructive position, though I noted that our approach still indicated the need to maintain a “stop loss” a few percent below those market levels in the form of index put options. Valuations are a far cry from reasonable today.

On the policy front, I believed in 2008 that it was appropriate for the Treasury to provide capital to banks through the use of preferred stock (though I would have advised the use of Bagehot’s Rule – which would have provided that capital at much higher yields than the Treasury accepted). However, I did not believe that outright purchases of distressed assets were appropriate or ethical, and I railed against the notion of a Troubled Assets Relief Program (TARP), as well as Fed purchases of Fannie Mae and Freddie Mac’s liabilities, FASB accounting changes to reduce the transparency of financial reporting, and other interventions to defend bondholders and put bad private assets on the public balance sheet.

As the government pursued those more outrageous policies, it became clear what I had expected to be a fairly orderly “writeoff recession” (involving the appropriate restructuring of bad debts) was not going to happen, and without that restructuring, that the U.S. economy would be chained to the burden of those debts for a very long time. The inability of the economy to materially accelerate in recent years, and its constant hovering at the edge between expansion and recession, is a symptom of that failure to restructure debt in 2008 and early 2009. One cannot account for the full cost of defending bondholders during the crisis without adding in the trillions of dollars in additional government debt that has been expended in the effort to counteract that economic drag.

I am glad that the economy has created jobs recently. But payroll employment is not a forward-looking indicator, and is unlikely to prevent the U.S. from joining a global downturn that is already in progress among developed countries.