John P. Hussman of Hussman Funds examines permanently high plateaus in the market and their poor precedents in  a recent installment of Hussman Funds’ Weekly Market Comment. He predicts a market retreat over the completion of the current market cycle, and estimates small total returns  and possible negative real returns. However, Hussman has some good news. “The most favorable market return/risk profile we identify is associated with a material retreat in market valuations that is then joined by an early improvement in our measures of market action.”

Hussman addresses the idea that low interest rates ensure permanently high plateaus, pointing out that the historical correlation between Treasury yields and reliable measures of market valuation is extremely low, and generally low interest rates are associated with lower stock  valuations. Hussman views the intentional distortion of the financial markets by the Federal Reserve as a mistake. The Fed and central banks are trying to encourage economic stability, and speculators are willing to believe they have created a permanently high plateau. “Even though speculative episodes are ultimately temporary, their effect is to lock investors, in aggregate, into holding  low-quality liabilities that are issued during the bubble, and these liabilities become fodder for  the next crisis. Hussman Funds’ outlook remains fairly neutral.  Present market conditions are associated with a relatively high probability of incremental market gains and a modest  probability of steep losses. Hussman cautions “Now is not the time or circumstance to accept material downside risk.”