Expert Warns of 66% Drop Scenario Amid Speculation

• Stock valuations by some measures are at all-time highs.
• John Hussman says this bodes poorly for future market returns.
• He warned of potential negative returns over the next 12 years, and a possible 66% crash.
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It’s become a common justification among investors for record-high current stock market valuations: it’s Fed support.

The heightened liquidity in the market thanks to zero interest rate policy and the $120 billion per month in asset purchases from the US central bank explain and excuse steep valuations, so the argument goes. Another argument is that S&P 500 earnings have outstripped analysts’ expectations since the depths of the pandemic last year.  

But to John Hussman, the president of the Hussman Investment Trust, that’s all wrong. And investors are making a grave mistake in believing this narrative. 

Hussman, who called the dot-com bubble, wrote in a recent note that investors are misunderstanding how

Federal Reserve
stimulus actually props up markets. Its real effect is on investor psychology, he said. In other words, even if the Fed continues to supply

liquidity
, it doesn’t necessitate that stocks will remain elevated or be immune to poor performance.

“The thing that ‘holds the stock market up’ isn’t zero-interest liquidity, at least not in any mechanical way. It’s a particularly warped form of speculative psychology that rules out the possibility of loss, regardless of how extreme valuations have become,” Hussman wrote in a September 12 note.

“We’ve never seen this much zero-interest base money before, but we certainly have seen the speculative psychology it relies on, and it has always ended in tears,” he added.

As implied at the end of the above quote, Hussman warned that this speculative investor mindset will have serious consequences. 

For one, current valuations — which Hussman says are the “most extreme in history” — make it likely that future stock market returns are severely muted. Hussman’s model predicts that the S&P 500 will return -6% over the next 12 years.

To measure valuations, Hussman uses the ratio of total market capitalization to gross…