John Hussman Answers the “Key Question”

Some say there’s a great conundrum occurring in the market currently – how can we be on the verge of recession in the USA, in the midst of this continual depression in parts of Europe and still have the S&P 500 near the highs of the year?   John Hussman says he has the answer in this latest letter:

“The key question – in view of extreme credit market strains in Europe, and accelerating economic deterioration in the U.S. – is why the S&P 500 continues to trade within a few percent of its April bull market high. The answer is simple: investors are scared to death of missing the widely anticipated market advance that they expect to follow a widely anticipated third round of quantitative easing.”

I think it’s a bit more complex that just the Fed and QE3.  First, I don’t think the market is pricing in a recession, because, as Wall Street’s GDP consensus for the next few quarters clearly shows, a recession isn’t expected.  But more importantly, equity prices in the USA are primarily a function of corporate profits and even though there are signs of deterioration in profits neither the Euro crisis nor signs of deterioration in the US economy has actually led to a signification decline in profits.

So yes, I would agree with Dr. Hussman that the Fed plays an important psychological role here, but ultimately, it’s corporate profits that primarily drive the equity markets and while QE may have all sorts of mystical psychological impacts it is having very little impact on profits overall.  And until we begin to see significant deterioration in the profit picture we’re unlikely to see significant deterioration in the equity markets.*

* When I say “significant” I mean 20%+ declines consistent with bear markets. 


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Alberto

    I agree with you, not the first time ! For this reason I think is much more important to understand the real state of the economy in the EM where a lot of the incomes of the big multi national firms are earned. This also means understanding what a stronger dollar means because it’s well know that in the recent past a significant portion of those incomes were from EM currency appreciation respect the US$ (and euro of course). Last but not least: what about the financial sector in the US ? This should scary everyone. It performed much above his real merits. What’s the real balance sheet of the TBTB ? Intelligent people know that a relevant section of the liabilities are not in the books but parked outside. I believe that for these reasons the market is hugely overvalued but probably this is not tradable because the markets can decide to ignore these fact until too late (for longer and shorter too).

  • David

    Well, the profits of U.S. corporations so far have been pretty much in line with expectations.

    However, and this is something that is often missed, the revenues of said corporations have surprised to the downside in a very significant amount.

    A lot of companies are fudging their data a little bit. And everyone knows it’s the profits who are much more watched than revenues. So aside from the slight massaging of the numbers, you hire less, work your workers more, raise wages less and you get more profit.

    That revenues are down 10 % from a year ago means that the global economy is stagnating – at best. And if the current cooldown on the world economy persists, and there is no reason to think otherwise, then they won’t hire. And you can’t have a falling revenue base and an identical profit profile forever. At some point you need to expand, as you can’t shake down your workers more. You can always cut workers, of course. But even that is hard in this environment as many companies have already tried to do that in previous years.

    The ‘profit’ recession isn’t here, but the reveneue recession is, which is a prelude to the profit recession UNLESS the economy improves, as there will be more room to grow.

    I don’t see an outright recession on the horizon just yet, just more stagnation into 2013, which will put even more pressure on profits if revenues fail to pick up. And then, you’ll get outright contraction as the fiscal drag(I expect no more than 0.5 to 0.7 % at best) still does a lot of damage in a sub-2 % growth environment, with most of the deficits intact and rolled over to the next years. All this increases public debt. At some point, there has to be consolidation.

    My guess is that America won’t make that choice, because as the stagnation increases, talk of recession will in of itself be self-reinforcing and might just get us to a mild recession like the one we see in Britain, which does not have a large contraction but rather a prolonged zero-growth environment.

    And that environment could probably be maintained for years.

  • Anonymous

    QE3 is not coming…… the question becomes….. how long can this game be played until the “dumb” money realizes they have been manipulated……

    Recessions happen, as they always have.

  • Bond Vigilante

    One reason profits are so good is that people have pulled a lot of money out of stocks and poured that money into bonds, driving corporate yields lower and lower. Hence lower funding costs for corporations. The corporate bond market has become frothy lately.

    See these webposts from Sober Look:

    What about short term rates being very low ? Borrow at 0.25% and get a (much) higher return on a (high yield) corporate bond.

    Trading volume has decreased in the last three years. So, where are the investors Hussman is talking about ?

  • michael schofield

    Allow me to add to the confusion. Money has to be somewhere and the U.S. markets are the least worst option. When the bond market butts heads with the stock market, the bond market usually wins. If it wasn’t for the threat of a CB boot to the teeth, what would short interest be right now? If you’re certain of what to do here you’re way ahead of me. 100% cash here.

  • Alberto

    Not to mention that the real tax rate of corporates is at the lowest. Etically this is unquestionably terrible but what really matter is “how much longer this will be politically sustainable ?”

  • Alberto

    Of course not “corporates” but big corporations like GE, Google etc…

  • David

    For those of you who subscribe to the Financial Times, they too, have noticed the collapse of revenues among U.S. companies.

    Key quotes:

    “Estimates of revenue growth for the largest US companies are being scaled back sharply by Wall Street analysts, signalling a mounting risk that the world’s largest economy may enter recession later this year.”


    “We are fast approaching levels where these estimates are unambiguously pointing to the risk of a US, global recession later in 2012 and into 2013,” said Nicholas Colas, chief market strategist at ConvergEx Group.”

  • Johnny Evers

    Hussman is saying that present corporate profits don’t justify the high multiples.
    Also, Hussman is a fundamentalist, and there are very few of those today. Some investors trade on momentum. Some trust the Fed to intervene to keep markets high. Some are always long.

  • Mike Bell

    Moral hazard anyone?

  • jt26

    This doesn’t apply to Hussman, but it seems the last year that everybody is jockeying to be the Roubini for 2012, the first to predict the next great recession/calamity. But, in a Rosenberg-Farell universe, “the opposite will happen”.

  • Brandon

    You’re explanation would have been correct last year, but the market went down %20, so what’s really different this year ?

    That being said, the market is maybe waiting for the right catalyst before it really sells off.

  • InvestorX

    “as Wall Street’s GDP consensus for the next few quarters clearly shows, a recession isn’t expected.”

    -> When was the last time a recession was correctly (officially!) expected by Wall Street? I doubt there is such a phenomenon.

    “equity prices in the USA are primarily a function of corporate profits and even though there are signs of deterioration in profits neither the Euro crisis nor signs of deterioration in the US economy has actually led to a signification decline in profits.”

    -> Agree, but let’s look under the surface:
    1) How much of those are phony banking “mark-to-fantasy” profits?
    2) The decline in revenues is there, question is when does it hurt profits?

    And finally: You get the European inflows, money leaving the EU area, pushing US assets up (bonds AND stocks)

  • jcinvests

    Cullen–excellent post as usual. I do take the other side of your opinion, though.

    Here’s my blog post response at:

  • Cullen Roche

    JC, great stuff! How would you like to repost here? I think the opposing side of the argument is great and readers will enjoy it. If not, no big deal. Thanks.

  • jcinvests

    Cullen, thanks, yes I would like to. I’m not sure how to logistically ‘re-post’. Is that handled on your site or throug mine?

  • Cassandra

    Perception of corporate profits is being manipulated to manipulate the market.
    Any company can beat estimates if expectations are revised low enough.

    The key question is why people behave as if more QE would be a good thing?
    Why do people want more of what hasn’t worked? Doing the same thing expecting different results is the definition of insanity.