Hussman on investors taken for suckers + Don't Take the Bait

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Subject:	FWC: Hussman on investors taken for suckers + Don't Take the Bait
Date:	Tue, 20 Jul 2010 14:54:17 -0700
From:	Jas Jain

FWC: Hussman on investors taken for suckers + Don't Take the Bait

AS (my emphasis): "Hussman is spot on, the stock market has become a giant scam.  A grab bag for fraudsters and corporate insiders.   Hussman is pitifully late in coming to that conclusion though.  He's also unable to let go of the past as he is still "investing" in stocks.   Even worse, Hussman has been a commodities bull based on ballooning reserves and the inflation he thinks they will cause.  Only now is Hussman starting to grasp deflation and depression. 

"As educated as Hussman is, he has some seriously flawed logic.  He admits the stock market is ridden with fraud, yet believes he won't get scammed.   He complains about the bailouts, yet without the bailouts, his stock "investments" would be worth far less (even with his hedges). 

"Over the past five years, investors in Hussman's Growth Fund are underwater after fees and taxes.  The losses extend even further back when inflation is factored in and the fund is less than 10 years old.   And here's the thing, the majority of the money Hussman manages in the growth fund was received in the past five years.  It's very likely that Hussman's growth fund, in aggregate, has lost more money than it has gained.  And the gains in the early years were very likely a chance event as the fund came into existence during the dot.com bust when bargains could be found and the Fed got stupid with policy giving all stocks a boost. 

"Hussman doesn't want to admit that you can't compete with stupidity.  If he did, he'd have to admit that he has been a dupe for years.  Most people, especially the highly educated, can't ever acknowledge that they were duped.  Their egos just can't handle it." 

 

Thanks. If one has the skills, very expensive to acquire!, one should bet against stupidity! But, it is a dangerous game. My advice since 1998, when I concluded that the old US stock market had been converted into the Scam Market, has been to avoid Scams. I apologize for bruising American egos (American egos need lot more than bruising; they need to be hammered non-stop!) but there is no greater disability in understanding the American economy, investments and political system than being a born-and-bred American. It is a deep hole to crawl out of. And Hussman is no exception.

Jas

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Hussman on investors taken for suckers

On the surface, we observe consumers that have borrowed far beyond their actual incomes to consume output, while corporations have booked what appear to be strong profits. Financial companies, in particular, have contributed a disproportionately large share of S&P 500 profits over the past decade, and have been the primary drivers of observed profit recovery over the past year. Below the surface, however, an increasingly large fraction of reported profits has been written off as "extraordinary charges" due to credit losses and writeoffs of bad investments. Reported "operating earnings" have been substantially above the amounts that have actually been delivered to shareholders, either through dividends, increases in book value, or share repurchases in excess of grants to insiders.

Think about this for a moment. Since the late 1990's, many employees have earned paychecks for producing capital goods that did not turn out to be worth what companies spent, and consumers have received loans for amounts which they are not actually able to repay. Both of these outcomes have been the economy's way of forcing a large but rather overlooked "correction" in the income distribution back from corporate profits (and by extension shareholders) and toward the average American worker.

All of this is extraordinarily inefficient, because some people have effectively received windfalls (for example, those who sold their homes at the top of the real estate bubble, and those who have defaulted on large amounts of consumer credit), while other hard-working people have been stiffed. But one way or another, the equilibrium outcome of the economy has been to ensure - whether the transfer of purchasing power was voluntary or not - that American workers were able to purchase the output that was actually produced by the economy.

What's fascinating about this, however, is that shareholders are still ignoring it. They also ignore the large percentage of reported earnings that are actually quietly distributed to corporate insiders through the issuance of stock and options. They blindly accept that "share repurchases" are somehow a pleasant distribution of earnings, whereas the majority of share repurchases are actually made by companies to do nothing more than offset the dilution from stock shares and options granted to insiders. A good question to ask in the years ahead, immediately after profits are reported, is "how much of this figure is actually delivered to shareholders?" If you've been attentive over the past decade, the answer turns out to be much closer to the dividend yield than to the operating earnings yield that companies have reported.

For a moment, at least, it is good to be a corporate insider, particularly at major financial companies. First, you get to report productivity gains and "operating profits" - not by making smart investments in productive assets, but instead by writing up debt thanks to Treasury intervention, by misstating your balance sheet thanks to FASB changes last year, and at industrial firms, by cutting the number of workers per unit of capital. Next, you quietly write off large losses on bad investments and unrecoverable loans as "extraordinary expenses," to which investors pay no notice. And to add insult to injury, you deliver a significant portion of the remaining profits to yourself as "incentive compensation," followed by buybacks of stock to offset the dilution, which investors actually cheer because they don't realize they've been taken for suckers.

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Hussman: Don't Take the Bait

Investors who allow Wall Street to convince them that stocks are generationally cheap at current levels are like trout - biting down on the enticing but illusory bait of operating earnings, unaware of the hook buried inside.

I continue to urge investors to have wide skepticism for valuation metrics built on forward operating earnings and other measures that implicitly require U.S. profit margins to sustain levels about 50% above their historical norms indefinitely. Forward operating earnings are Wall Street's estimates of next year's earnings, omitting a whole range of actual charges such as loan losses, bad investments, restructuring charges, and the like. The ratio of forward operating earnings to S&P 500 revenues is now higher than it has ever been. Based on historical data (see August 20, 2007 Long Term Evidence on the Fed Model and Forward Operating P/E Ratios), the profit margin assumptions built into forward operating earnings are well beyond two standard deviations above the long-run norm. This is largely because, as Bill Hester noted in his research article last week, forward operating earnings are heavily determined by extrapolating the most recent year-over-year growth rate for earnings. In the current instance, this is likely to overshoot reality, and in any event, has little to do with the long-term cash flows that investors can actually expect to receive over time.

I can't emphasize enough that when you hear an analyst say "stocks are cheap based on forward operating earnings" it would be best to replace that phrase in your head with "stocks are cheap based on Wall Street's extrapolative estimates of a misleading number."

More sober and historically reliable measures of market valuation create a much more challenging picture. Apart from our own measures, which indicate continued overvaluation, there are several good indicators of market valuation that are not overly sensitive to year-to-year fluctuations in profit margins. One is based on the 10-year average of actual net (not operating) earnings, which is advocated by economist Robert Shiller, and another is Tobin's "q" ratio which is based on comparing market value to replacement cost, and is advocated by Andrew Smithers. Both of these measures largely agree with our own measures, both presently and on a historical basis. Based on last week's valuations, both suggest that the S&P 500 is substantially overvalued.