December7,2015

FromRisktoGuardedExpectationofRecession
JohnP.Hussman,Ph.D.
Allrightsreservedandactivelyenforced.
ReprintPolicy

Onthebasisofvaluationmeasuresmostcloselycorrelatedwithactualsubsequent1012yearS&P500total
returnsinmarketcyclesovermorethanacentury,arankingofthemostovervaluedextremesinU.S.history,
inorderofseverity,includes:2000,2015,1929,2007,1937,1907,1968,and1972.Whilethe196970retreat
tooktheS&P500downbyonlyonethirdofitsvalue,eachoftheotherinstanceswasfollowedbymarket
lossesof50%ormoreoverthecompletionoftheirrespectivemarketcycles.Giventhat2015isthesecond
highestvaluationextremeonrecord,suchanoutcomeisnotsomeworstcasescenario,butisinsteada
ratherrunofthemillexpectation.
Notably,the2000marketpeakwasdominatedbylargecapitalizationstocksandthetechnologysector.The
recentFedinducedspeculativebubbleactuallybroughtthevaluationofthemedianstockbeyondthe2000
extreme,markingthemostoffensivepointofovervaluationinhistoryforthebroadmarket.A50%marketloss
wouldnotevenbringthemosthistoricallyreliablevaluationmeasuresmateriallybelowtheirlongterm
averages.
Thefollowingchart,showingtheratioofnonfinancialmarketcapitalizationtocorporategrossvalueadded
(redline,leftscale,inverted)versustheactualsubsequent12yearnominaltotalreturnoftheS&P500(right
scale),placescurrentvaluationsandprospectivereturnsinahistoricalcontext.Inourexpectation,thelikely
totalreturnoftheS&P500overthecoming12yearsislikelytobeapproximatelyzero,thoughwithoneor
moreextraordinarilydeepinterimlossesonthewaytozerooverallreturns.Recallthatthesameoutcome
emergedinthe12yearperiodfollowingsimilarvaluationextremesin2000.Nearlythesameoutcomefor
nominalreturnsalsofollowedthelate1968extreme,andtheoutcomewasidenticalinrealterms,astheS&P
500followedbothextremeswithnegativerealtotalreturnsovera12yearhorizon.

ThesingularconsequenceofyearsofintentionalFedinducedspeculationandzerointerestratepolicyhas
beenthethirdspeculativebubblein15years.Weviewthisbubbleasbeinginalatestagetopformation.
Marketinternalshavedeterioratedacrossabroadrangeofindividualstocks,industries,sectors,andsecurity
types(includingdebtsecuritiesofvaryingcreditworthiness),andthisdeteriorationindicatesthatextreme
valuationshavenowbeenjoinedbyapersistentshifttowardriskaversionamonginvestors.
Wheninvestorsareinclinedtospeculate,theytendtobeindiscriminateaboutit.Theresultisuniformly
advancingmarketactionacrossabroadrangeofriskyinvestments.Theconditionofinvestorrisk
preferences,asconveyedbytheuniformityordivergenceofmarketinternals,hashistoricallybeenthecentral
featurethatdistinguishesabubblethatcontinuestoadvancefromabubblethatispronetoverticalcollapse.
AsIwroteinOctober2000,justbeforetheS&P500losthalfofitsvalue,whiletheNasdaq100wasjust
beginningits83%collapse:
Historically,whentrenduniformityhasbeenpositive,stockshavegenerallyignoredovervaluation,nomatter
howextreme.Whenthemarketlosesthatuniformity,valuationsoftenmattersuddenlyandwithavengeance.
Thisisalessonbestlearnedbeforeacrashratherthanafterone.Valuations,trenduniformity,andyield
pressuresarenowuniformlyunfavorable,andthemarketfacesextremeriskinthisenvironment.
Ourmarketoutlookshiftedtotheconstructivesideinearly2003,andFedinducedspeculationgradually

createdanotherbubble,thistimeinhousingaswellastheequitymarket.Withfewexceptions(suchasa
relativelyshallowcorrectionin2006),Fedinducedyieldseekingspeculationpersisteduntilmid2007.AsI
wroteinJulyofthatyear,justbeforetheglobalfinancialcrisistooktheS&P500downbymorethan55%:
Oneofthebestindicationsofthespeculativewillingnessofinvestorsistheuniformityofpositivemarket
actionacrossabroadrangeofinternals.Probablythemostimportantaspectoflastweek'sdeclinewasthe
decisivenegativeshiftinthesemeasures.SinceearlyOctoberoflastyear,Ihaveatleastgenerallybeenable
tosayintheseweeklycommentsthatmarketactionisfavorableonthebasisofpricetrendsandother
marketinternals.Now,italsohappensthatoncethemarketreachesovervalued,overboughtandoverbullish
conditions,stockshavehistoricallylaggedTreasurybills,onaverage,evenwhenthoseinternalshavebeen
positive(afactwhichkeptushedged).Still,thefavorablemarketinternalsdidtellusthatinvestorswerestill
willingtospeculate,howeverabruptlythatwillingnessmightend.Evidently,itjustended,andthereversalis
broadbased.
Putsimply,marketinternalsarethehingethatdetermineswhetheranovervaluedmarketadvanceislikelyto
persistorcollapse.Understandingthiswascentraltodistinguishingthetechandhousingbubblesfromtheir
subsequentcrashes.IveregularlydetailedwhywefailedtobenefitfromthislessonduringtherecentFed
inducedbubble,anditsessentialtounderstandthatnarrativebeforetheopportunitytodefendagainstalikely
oncomingmarketcollapseislost.
In2009,followingthefinancialcrisisthatwehadanticipated,theseverityofmarketandeconomicoutcomes
becameoutofsamplefromthestandpointofthepostwardataourclassificationmethodswerebasedon.I
insistedonstresstestingourmethodsagainstDepressioneradatawhichmadethemmuchmorerobustto
extrememarketoutcomes.Butthosemethodsofclassifyingmarketreturn/riskprofilesalsopickedupanother
historicalregularity:inmarketcyclesacrosshistory,theemergenceofsufficientlyextremeovervalued,
overbought,overbullishconditionswasregularlyfollowedbysteepairpockets,panicsorcrashes.Asa
result,Iimmediatelytookadefensiveoutlookwhenthoseconditionsemerged.Butifquantitativeeasing
madetherecentbubbledifferentfromothermarketcyclesacrosshistory,itdidsobyintentionally
encouragingpersistentspeculationevenafterextremelyoverextendedconditionsemerged.Inthepresence
ofQEandzerointerestratepolicy,onehadtowaituntilmarketinternalsdeterioratedexplicitlybefore
adoptingastronglynegativemarketoutlook.Weimposedthatrequirementonourmethodsinmid2014.
Thatsingleadaptationcouldhavesparedusagreatdealoffrustrationinrecentyears.Havingaddressedthat
issueinmid2014,Iveembeddedthecentrallessonindozensoftheseweeklycomments,becausedetailing
theimportanceofmarketinternalsinnavigatingvaluationbubblesandcrashesacrosshistory(includingthose
since2000)overshadowswhateverrisktheremaybeinrepetition.Frankly,itstrikesmeasfoolishthatsome
observerswouldprefertousemyerrorinthiscycleasapretensetoignoreobjectivelyobscenevaluationson
historicallyreliablemeasures,ratherthanlearningfromthisexperienceinawaythatmighthelpshieldthem
fromviolentmarketlossesthatnowappearinevitableoverthecompletionofthiscycle.
Thatsaid,Ihavenoobjectiontoinvestorsfollowingapassiveinvestmentstance,providedthattheyve
alignedtheirportfoliowiththeirinvestmenthorizonandactualrisktolerance(allowingforthepossibilityin
myviewthelikelihoodofaninterimlossontheorderof50%,asthemarketexperiencedin20002002and
20072009).Itsnotcleartomethattheexistingvolumeofoutstandingequitiescouldactuallybeabsorbedby
investorsattheircurrentvaluationsifinvestorsweretoproperlyaligntheirportfolioswiththeirrisktolerances
andinvestmenthorizons,yetsomebodyhastoholdeveryshareofstockoutstanding,ateverypointintime.
Hopefully,thosechoosingspeculativeinvestmentpositionsatthesevaluationshaveatleastconsideredand
rejectedourconcerns.
FromRisktoGuardedExpectationofRecession
Lastweekbroughtanotherdevelopmentmatchingwhatweobservedbothin2000and2007.Inadditionto
anticipatingthemarketcollapsesthatfollowedthoseextremes,Iamamongthefeweconomistswhocorrectly
warnedofoncomingrecessionsinOctober2000andagaininNovember2007bothpointswheretheconsensus
ofeconomicforecastersindicatednoexpectationofoncomingtroubleatall.Inbothinstances,theearliest
signalofeconomictroublecamefromourRecessionWarningComposite,coupledwithdeteriorationinbroad
marketinternals.Theevidencedrivingourpresentconcernsdoesnotrelyondatathatissubjecttorevision,
hasnotbeeninplacesincetheglobalfinancialcrisis,andsuggeststhattheU.S.economicoutlookhasnow

turnedtowardnotjusttheriskbuttheguardedexpectationofrecession.Iusetheword"guarded"because
weshouldacknowledgethatthistimemaybedifferent,particularlyintheeventthatbroadmarketinternals
improvesubstantially,butweshouldalsoemphasizethatrecessionisnowthebasecase.
ApossibleFedratehikehasnothingtodowiththeexpectationofrecession,andagain,themainfactorthat
wouldreduceourconcernswouldntbeeasyFedpolicybutratheranimprovementinmarketinternals.Asin
2000and2007,economicweaknessisnotapparentifonefocusesonlaggingindicatorssuchas
employment.Whileoureconomicconcernsarebasedonamuchbroadersetofevidencethanourrelatively
narrowRecessionWarningComposite,werenotpoundingthetableaboutrecessionthecombinationof
extremevaluationsandpoormarketinternalsalreadyholdsustoadefensiveinvestmentoutlook,andfurther
economicdeteriorationwillbenecessarytoconfirmthisveryearlyexpectationofrecession.
IshouldimmediatelyacknowledgethatIincorrectlyexpectedarecessionin201112.Giventhatthe
consensusofeconomistshasnevercorrectlyanticipatedarecessionatanypointinU.S.economichistory,
thefactisthatanyapproachthatissensitiveenoughtoidentifyarecessionearlyonrunstheriskofan
occasionalfalsesignal(theclassicdilemmabetweenTypeIvsTypeIIerrors).AsInotedseveralweeksago,
thesignalfromourRecessionWarningCompositein201112wastriggeredbyashortfallinemployment
growth(whichwehadusedasanalternatetocondition4below)thatwassubsequentlyrevisedaway,sothe
lastsignalonthiscompositeinthereviseddataappearsduringtheglobalfinancialcrisis.Ourcurrent
concernsarentdrivenbydatasubjecttorevision.
Moreover,asBillHesterhasnicelydemonstrated,tepideconomicdatahassignificantlydifferentimplications
forrecessiondependingonwhetherornottheequitymarketisweakeningaswell.Duringthe201112period,
weneversawtheISMPurchasingManagersIndexbelow50whentheS&P500wasalsobelowitslevelof6
monthsearlier.Priortothisweek,thelasttimeweobservedeventhatbasiccombinationwasin2009.Aswith
ourotherchallengesinthisperiodofextraordinarymonetarydistortion,agreateremphasisonmarket
internals(whichweimposedonourmethodsinmid2014)wouldhavesparedusagreatdealoffrustrationin
recentyears.
Abroadimprovementinmarketinternalswouldreducetheimmediacyofbothourmarketconcernsandour
economicconcerns.Atpresent,however,ourviewisthatbothfinancialandeconomicrisksaresubstantially
elevated.WecertainlybelievethatrecklessFederalReservepolicyhascontributedtoboth,bycreatingan
environmentthatfosteredpersistentspeculationandmisallocationofcapital.Butregardlessofwhetherthe
Fedhikesordoesnthikeinterestratesinthecomingweeks,dontthinkforasecondthatsuchamovewillbe
theactualreasonfordisruptionsthatarelargelybakedinthecakealready.
Thefollowingcriteria,fromtheOctober3,2000HussmanInvestmentResearch&InsightandalsomyNovember
12,2007commentExpectingARecession,detailsthebasicsyndromeofconditions(noneofwhichisparticularly
informativeinandofitself)thatcompriseourRecessionWarningComposite,whichisstronglyassociated
withU.S.economicdownturns:
1:Wideningcreditspreads:Anincreaseoverthepast6monthsineitherthespreadbetweencommercial
paperand3monthTreasuryyields,orbetweentheDowCorporateBondIndexyieldand10yearTreasury
yields.
2:Moderateorflatyieldcurve:10yearTreasuryyieldnomorethan2.5%above3monthTreasuryyields
(thisdoesn'tcreateastrongriskofrecessioninandofitself).
3:Fallingstockprices:S&P500belowitslevelof6monthsearlier.Again,thisisnotterriblyunusualby
itself,whichiswhypeoplesaythatmarketdeclineshavecalled11ofthepast6recessions,butfallingstock
pricesareveryimportantaspartofthebroadersyndrome.
4:WeakISMPurchasingManagersIndex:PMIbelow50.
Whilethissimplecompositehasastrikinglyreliablerecordinidentifyingoncomingeconomicweakness
comparedwithnumerouspopularalternatives,itsimportanttoreviewabroadersetofeconomicmeasures
forconfirmation.ThefirstisourfamiliarreviewofregionalandnationalFedandpurchasingmanagers
surveys.Thecontinueddeteriorationinleadingmeasures,particularlyneworders,isnotable.

AsIveoftenobserved,oneofthemorereliableleadingmeasuresofeconomicactivitycomesfromwhatIve
calledordersurplus:neworders,plusbacklogs,minusinventories.Thechartbelowpresentsthismeasure
sincethe1960s.Thecurrentdeteriorationislikelytoplacecontinueddownwardpressureonmeasuresof
productionandincome.Rememberalsothatemploymentmeasuresarenotleadingorevencoincident
indicators,butareinsteadlaggingindicatorsthattypicallyconfirm,inhindsight,whatthestateoftheeconomy
wasseveralmonthsearlier.

WhileregionalandnationalFedandpurchasingmanagerssurveyshavequiteagoodrecordasleading
indicatorsofeconomicactivity(particularlywhencombinedwithfinancialmarketindicators),theyare
emphaticallysurveybasedmeasures,andarenotquantitativemeasuresofordersoroutput.Inordertotrack
economicactivitymorebroadly,wefollowdozensofmeasuresrelatingtoorders,realoutput,retailsales,
capacityuse,employment,income,monetaryvariables,creditspreads,commodityprices,equitymarkets,
hoursworked,andsoforth.Thechartbelowshowsacompositeofthesemeasures,scaledinstandard
deviationsfromthenorm.Theredlineshowsthecurrentlevelofeconomicactivityacrossthisverybroadset
ofmeasures.ThegreenshadedareasareU.S.recessions.

Finally,thechartbelowprovidesaslightlydifferentview,showingonlythepointswheretheS&P500was
belowitslevelof6monthsearlier,inmonthlyclosingdata,andsettingotherpointstozero.Notably,whenthe
S&P500hasbeendownoverthepreceding6monthperiod,thepresentlevelofeconomicactivityhas
alwaysbeenassociatedwithoncomingU.S.recession,exceptforabriefpostrecessiondipin2003.Ifthe
recentbubbleperiodshouldencourageanything,itshouldbetoallowthepossibilitythatriskscouldbe
deferred(thoughprobablyalsomadeworseinthelongrun)byareturntospeculative,riskseekingbehavior.
Sufficeittosaythattheriskofrecessioniselevatedhere.Weneedntclaimcertainty,andIdontbelievethat
themonetaryandspeculativedistortionsofrecentyearsencourageit.Themainpointatpresentisthatwe
nowviewanoncomingU.S.recessionassignificantlymoreprobablethannot.

Inthepresenceofobscenevaluations,deterioratingmarketinternals,wideningcreditspreads,andtepid
economicactivityonthemosthistoricallyreliablemeasures,wepresentlyobservethesameessential
syndromeofriskfactorsthatallowedustoaccuratelyanticipatethe20002002marketcollapseand
recession,aswellasthe20072009globalfinancialcrisis.Emphatically,areturntoriskseekingbehavior
amonginvestors,asevidencedbyaclearimprovementinmarketinternalsacrossabroadrangeofindividual
stocks,industries,sectorsandsecuritytypes(includingdebtsecuritiesofvaryingcreditworthiness)would
defertheimmediacyofbothourmarketandeconomicconcerns.Intheabsenceofashifttoriskseeking
behavior(whichevenareturntoFedeasingwouldnotensure),myviewisthatthelikelihoodofasevere
marketdownturnandaU.S.recessionhassubstantiallyincreased.
TheforegoingcommentsrepresentthegeneralinvestmentanalysisandeconomicviewsoftheAdvisor,andare
providedsolelyforthepurposeofinformation,instructionanddiscourse.PleaseseeperiodicremarksontheFund
NotesandCommentarypagefordiscussionrelatingspecificallytotheHussmanFundsandtheinvestmentpositionsof
theFunds.

ProspectusesfortheHussmanStrategicGrowthFund,theHussmanStrategicTotalReturnFund,the
HussmanStrategicInternationalFund,andtheHussmanStrategicDividendValueFund,aswellasFund
reportsandotherinformation,areavailablebyclicking"TheFunds"menubuttonfromanypageofthis
website.
Estimatesofprospectivereturnandriskforequities,bonds,andotherfinancialmarketsareforwardlooking
statementsbasedtheanalysisandreasonablebeliefsofHussmanStrategicAdvisors.Theyarenota
guaranteeoffutureperformance,andarenotindicativeoftheprospectivereturnsofanyoftheHussman
Funds.Actualreturnsmaydiffersubstantiallyfromtheestimatesprovided.Estimatesofprospectivelongterm
returnsfortheS&P500reflectourstandardvaluationmethodology,focusingontherelationshipbetween
currentmarketpricesandearnings,dividendsandotherfundamentals,adjustedforvariabilityoverthe
economiccycle(seeforexampleInvestment,Speculation,Valuation,andTinkerBell,TheLikelyRangeofMarketReturns
intheComingDecadeandValuingtheS&P500UsingForwardOperatingEarnings).