Next stock market crash: Investors are forgetting history, says Hussman - Business Insider

John Hussman — the outspoken investor and former professor who's been predicting a stock collapse — thinks portfolio returns are headed for their worst 12-year returns in history. He points to stretched valuations and weakening market internals as fodder for his warning — and provides timely, data-driven examples to back his thesis.He says a 50% to 65% market crash over the course of this cycle would be “actually somewhat optimistic.”Hussman thinks that investors faith in the Federal Reserve's ability to mitigate a downturn is “uninformed” due to today's valuations.Click here for more BI Prime stories.As investors, we're naturally inclined to consult the past to discern a path forward.Many have spent lifetimes scouring the details of historical events and data points trying to hash out an accurate picture of where markets are headed in the future. And although history rarely repeats itself, it tends to rhyme.It's safe to say that John Hussman, the former economics professor who is now president of the Hussman Investment Trust, thinks investors need to brush up on their market history.“As I've demonstrated a thousand ways, regardless of the impact of speculation or risk-aversion over shorter portions of the market cycle, the higher the level of market valuations, the lower the long-term and full-cycle market returns that have ultimately followed,” he penned in a recent blog post. “Notably, both of these measures presently match or exceed their 1929 extremes.”The chart below depicts Hussman's proprietary margin-adjusted price-to-earnings measurement (red line, right scale) juxtaposed against the ratio of S&P 500 to actual value of subsequent dividends, discounted at 10% annually (blue line, left scale).The goal here is to depict the discounted cash flow value of the S&P 500. Both measures are nearing peaks seen in the run up to the Great Depression.

Hussman

As Hussman mentioned above, speculation can lead to substantial fluctuations in value over the short-term. However, he argues that over the complete market cycle, long-term returns are generally driven by valuations.Today, by Hussman's calculations, valuations are insinuating the worst total return outlook for a portfolio in history.The chart below shows his proprietary estimated 12-year annual total return for a conventional portfolio (60% stocks, 30% bonds, 10% cash — blue line) compared against the actual subsequent 12-year returns for that portfolio (red line).

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“At present market levels, we expect the S&P 500 to produce negative total returns over the coming 12-year period,” he said.To further his thesis, Hussman points to Warren Buffett's favorite valuation measure: the ratio of stock market capitalization to GDP. In the past, the world's most famous investor has referred to this metric as “probably the single best measure of where valuations stand at any given moment.”Right now, Hussman's data shows it's higher than ever.The chart below shows the current ratio between US equity market capitalization and GDP.

Hussman

“Frankly, I'm open to bullish arguments that rely on investors ignoring history because they've got a speculative bit in their teeth,” he said. “The problem is the condition of market internals doesn't even support that argument at present.”In the past, Hussman has emphasized the need for weakening internals to confirm the market's inability to trend higher.Today, he's seeing those internals deteriorate.Below is a chart of the S&P 500 depicted against the percent of stocks above their 200-day moving averages. Clearly, a divergence is afoot, implying that the internals watched by Hussman are softening.

Hussman/h/t barchart.com

Conventional wisdom says that the Federal Reserve should be able to step in to buoy markets the midst of a downturn. Hussman disagrees.“The idea that low interest rates somehow put a 'floor' under stock prices is a historically-uninformed delusion,” he said. “A market loss on the order of 60% would be wholly consistent with low interest rates and easy monetary policy, especially at the valuation extremes we observe at present.”He concluded: “Given that most market cycles end at valuations well below historical norms, a projected 50-65% market loss over the completion of this cycle is actually somewhat optimistic.”Hussman's track recordFor the uninitiated, Hussman has repeatedly made headlines by predicting a stock-market decline exceeding 60%and forecasting a full decade of negative equity returns. And as the stock market has continued to grind mostly higher, he's persisted with his calls, undeterred.But before you dismiss Hussman as a wonky perma-bear, consider his track record, which he broke down in his latest blog post. Here are the arguments he lays out:Predicted in March 2000 that tech stocks would plunge 83%, then the tech-heavy Nasdaq 100 index lost an “improbably precise” 83% during a period from 2000 to 2002Predicted in 2000 that the S&P 500 would likely see negative total returns over the following decade, which it didPredicted in April 2007 that the S&P 500 could lose 40%, then it lost 55% in the subsequent collapse from 2007 to 2009In the end, the more evidence Hussman unearths around the stock market's unsustainable conditions, the more worried investors should get. Sure, there may still be returns to be realized in this market cycle, but at what point does the mounting risk of a crash become too unbearable？That's a question investors will have to answer themselves — and one that Hussman will clearly keep exploring in the interim.