'All hell will break lose': A notorious market bear who called the dot-com bubble breaks down why stocks are due for volatility resembling 2000 and 2007 as speculation runs rampant — and warns that 'acceptable stock-market returns are screwed' (2024)

One might mistake this as a description of today's market environment without batting an eye. But it's actually from the November 2, 1929 issue of The Business Week magazine, published during the midst of the biggest stock market crash in history.

Hussman, the president of the Hussman Investment Trust who called the dot-com bubble over 20 years ago, thinks history is repeating itself. He thinks investors once again believe stock valuations will remain high forever. And he thinks they're once again making a grave mistake.

Valuations are far extended beyond norms, by many measures. Hussman believes they will eventually come back to their norms, by the law of equilibrium.

In the chart below, Hussman illustrates how high stocks currently are above valuation norms, which he measures by market cap to gross value added and margin-adjusted price-to-earnings ratios.

Because Hussman believes valuations will eventually return to norms, he believes stock market returns in the years ahead will be terrible. He said stocks will go "nowhere in an interesting way." Examples of this happening are shown in the above chart. See: 1962-1974 and 1997-2008.

"The moment you look at where starting valuations are, you already know that, in all probability, the prospects for acceptable stock market returns are screwed," he wrote.

Hussman isn't alone in his critique of valuations. In a note earlier this month, Bank of America Chief US Equity Strategist Savita Subramanian said the bank's model expects annualized returns of 0% for the over the next decade given today's valuations, not including dividends.

Instead of poor returns and big sell-offs, one possibility is that GDP growth and inflation lift valuations back to appropriate levels. But over the next 13 years, to get back to valuation norms, GDP would have to grow by 10% annually or inflation would have to rise over 8% annually — both are highly, highly unlikely.

Hussman also railed against the Federal Reserve and its role in propping up markets through easy monetary policy. He believes investors and the Fed itself have bought into a narrative that the central bank's support props up stocks by necessity through its quantitative easing. But that narrative will end eventually, he said, causing chaos.

"The Fed has become almost entirely reliant on a narrative that its actions 'support' the financial markets," he wrote. "When that narrative breaks – because it is in fact a narrative, not a mechanistic relationship – all hell will break loose, as it did in 2000-2002 and 2007-2009 despite persistent Fed easing."

Hussman's track record — and his views in context

There is a camp on Wall Street that also believes stocks are too extended at the moment.

Stifel's Chief US Equity Strategist Barry Bannister said this week that he expects a 10% correction this quarter, triggered by monetary tightening around the world. He also pointed to the absurdity of the 97% gain the S&P 500 has seen over the last 18 months.

"Excluding dividends, the price of the market doubles every 10 years," Bannister told Insider.

Bannister's end-of-year S&P 500 price target of 4,000 matches those of the top strategists at Morgan Stanley, Citigroup, and BTIG. The 4,000 mark would be a nearly 12% pullback from current levels around 4,545.

Other strategists on Wall Street think stocks have a bit of room to run. The most bullish among them are Wells Fargo's Chris Harvey at 4,825 and Bank of Montreal's Brian Belski at 4,800. Goldman Sachs, JPMorgan, and Oppenheimer all have their targets at 4,700.

But beyond this year, it is difficult to tell where stocks will go, with uncertainty remaining around how transient inflation will be and how exactly the Fed will handle its monetary policy, potentially under a new chair. There is also uncertainty around the state of the economy, with job growth slowing, inflation rising, and industrial production slowing down, but spending remaining strong.

For the uninitiated, Hussman has repeatedly made headlines by predictinga stock-market decline exceeding 60%and forecasting afull decade of negative equity returns. And as the stock market has continued to grind mostly higher, he's persisted with his doomsday calls.

But before you dismiss Hussman as a wonky perma-bear, consider his track record, which he broke down in a recent blog post. Here are the arguments he lays out:

• He 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 2002.
• Predicted in 2000 that the S&P 500 would likely see negative total returns over the following decade, which it did.
• Predicted in April 2007 that the S&P 500 could lose 40%, then it lost 55% in the subsequent collapse from 2007 to 2009.

However, Hussman's recent returns have been less-than-stellar. His Strategic Growth Fund is down about 48% since December 2010, though it's risen 2.2% in the past year. Still, the S&P 500 has returned more than 31% over the same period.

The amount of bearish evidence being unearthed by Hussman continues to mount. 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.