John Hussman's Latest Weekly Market Commentary

In his current market commentary, "Ambiguous Conditions Warrant Moderation", Dr. Hussman gives his opinion on the comparisons of today's economic environment to the Great Depression, finishing with a clever simile:

We continue to hear remarks that the current economic downturn is the worst since the Great Depression. While the prices of stocks and other financial assets have certainly suffered a great deal, by any reasonable measure of output and employment, this isn't even close to being the worst economic downturn since the Depression. Even after November's awful job report, and including all of the downward revisions, the U.S. economy would have to lose twice as many jobs as it has already lost even to be on par with the 1981-82 recession (measuring job losses as a percentage of the labor force).

While we do expect fourth-quarter GDP to come in at a loss of -4% to -6%, it is important to recognize that this is a quarterly change at an annual rate. The overall contraction in U.S. output will be somewhere about 1-1.5% in the fourth quarter. In the Great Depression, actual GDP dropped by 30%. Ben Bernanke was correct in remarks he made last week that there is “an order of magnitude” (10 fold) difference between the current downturn and the Great Depression. For the record, the worst overall drawdowns in GDP since the Depression – not just bad quarterly growth rates – were in 1954 (-2.65%), 1958 (-3.75%), 1975 (-3.10%), and 1982 (-2.87%).

This is not to minimize the prospects for a further economic downturn, but to say that this is “the worst economy since the Great Depression” is like blowing up a crate of dynamite on the Nevada Proving Grounds and saying it is the worst explosion since the detonation of the atomic bomb there. Even if the statement is accurate, the comparison is absurd.

Unlike Bill Gross and John Authers (see "Bill Gross on Stock Valuations"), Hussman does not believe corporate bonds are more attractive than equities at this point:

Corporate yields have increased significantly, but default rates tend to pick up in the later stages of recessions, and there isn't much historical evidence to suggest that corporate bonds reach their lows any earlier than stocks do. For that reason, corporate bonds are essentially equity-equivalents here, and the same considerations about quality apply as well here as they do for stocks. Generally speaking, corporate bonds are currently priced to deliver both lower long-term returns than stocks, but as a group, will probably have lower volatility than stocks as well. Our inclination to invest in corporates for the Total Return Fund will likely increase at about the same time as our willingness to hold stocks on an unhedged basis for Strategic Growth (which is not yet).

Bill Gross on the Q Ratio

For commenter Dr. Paul Price, aka Stockdoxc, who prefers to see the glass as half-full, above is the Q Ratio chart from Bill Gross's December Investment Outlook, and below is Gross's explanation of the metric.

I believe in stocks for the long run – but only if purchased at the right price. That statement packs a real punch. It says that capitalism is and will remain a going concern, that risk-taking – over the long run – will be rewarded, but only from a starting price that correctly anticipates the economy’s growth and its share of after-tax corporate profits within it. Acknowledging the above, let’s look at a few basic standards of valuation that historically have stood the test of time, to see if at least the price is right.

One of them is what is known as the “Q” ratio, or the value of the stock market relative to the replacement cost of net assets. The basic logic behind “Q” is that capitalism works. If the “Q” is above 1.0, then the market is valuing a company at more than it costs to reproduce it; stock prices should fall. If it is below 1.0, then stocks are undervalued because new businesses can’t be created at as cheap a price as they can be bought in the open market. In the short run, this ratio is volatile as shown below but it tends to be mean reverting, which is critical. As long as capitalism is a going concern, “Q” should mean revert to 1.0. If so, then oh, oh what a “Q”! Today’s Q ratio has almost never been lower and certainly not since WWII, implying extreme undervaluation, as seen in Chart 1.

Bill Gross on Stock Valuations

In his December Investment Outlook ("Dow 5000 Redux"), PIMCO's Bill Gross writes that regulatory and other responses to the current financial crisis will have a 'transgenerational' impact on stock market valuations:

My transgenerational stock market outlook is this: stocks are cheap when valued within the context of a financed-based economy once dominated by leverage, cheap financing, and even lower corporate tax rates. That world, however, is in our past not our future. More regulation, lower leverage, higher taxes, and a lack of entrepreneurial testosterone are what we must get used to – that and a government checkbook that allows for healing, but crowds the private sector into an awkward and less productive corner. Dow 5,000? We don’t have to go there if current domestic and global policies are focused on asset price support and eventual recapitalization of lending institutions. But 14,000 is a stretch as well. One only has to recognize that roughly 20% of bank capital is now owned by the U.S. government and that a near proportionate share of profits will flow in that direction as well. Better to own corporate bonds than corporate stocks, but that’s a story for another Investment Outlook.

The chart above, of historic P/E values, comes from Gross's Investment Outlook.

Bill Gross Estimates the Yield-to-Government on an RTC-like Rescue Plan

In an op/ed in today's Washington Post ("How Main Street Will Profit"), PIMCO's Bill Gross estimates that the government could make 7%-8% by investing in distressed mortgage assets:

I estimate the average price of distressed mortgages that pass from "troubled financial institutions" to the Treasury at auction will be 65 cents on the dollar, representing a loss of one-third of the original purchase price to the seller, and a prospective yield of 10 to 15 percent to the Treasury. Financed at 3 to 4 percent via the sale of Treasury bonds, the Treasury will therefore be in a position to earn a positive carry or yield spread of at least 7 to 8 percent.

This doesn't take into account the proposals for the government to take equity stakes in the institutions that participate in these auctions, but as Wharton Prof. Jeremy Siegel noted earlier today on CNBC, if the government takes equity stakes in participating companies, it may be willing to offer higher prices that it would offer otherwise for the troubled assets.

Bill Gross's Open Letter to Barack Obama

In his July Investment Outlook, the manager of the world's largest bond fund offers some advice and predictions to the man he thinks will be the next president: "Dear President Obama".

I don't agree with all the politics there, but that's immaterial. What's of interest, from an investing perspective, is Bill Gross's prediction that an additional $500 billion in government spending will be needed to stimulate the economy; that this will lead to our first $1 trillion deficit, rising inflation, and rising bond yields over the next 4-8 years. "Your term will not go down in history as investor friendly.", Gross writes.

If the views of Jim Rogers and Vitaliy Katsenelson on U.S. stock market over the next several years didn't give you pause, perhaps Bill Gross's predictions will. Those who follow traditional financial planners' suggestions about asset allocation (e.g., keeping a large percentage of one's portfolio in domestic stock and bond index funds) may come to regret it.