Hussman: S&P 500 to hit 1,800?

The Federal Reserve's decision last week not to slow its rate of bond purchases has forced the bearishly-oriented fund manager John Hussman to consider the possibility of a short-term surge in the stock market.

Last week, the Federal Open Market Committee surprised investors by deciding at its monetary policy meeting on Wednesday not to taper the Fed's rate of bond purchases. Chairman Ben Bernanke said at a press conference after the meeting that the tightening of financial conditions in recent months could slow economic growth even as conditions in the United States job market remain “far from what all of us would like to see”.

Stocks in the United States reacted positively to the decision. The Standard & Poor's 500 Index rose 1.2 percent on Wednesday to close at a record high of 1,725.52.

In his latest article entitled “Psychological Ether”, John Hussman says that with the Fed's decision last week, it is possible, although not necessarily his forecast, that “the conditions for a final wave of speculation may have been created” and that we could see “an advance above 1800 in the S&P 500 over a period of about 6 weeks”.

“Unfortunately, even though the equity market has been rising on what we view as nothing but noxious psychological ether, the FOMC has – perhaps unintentionally – released another tank of the stuff,” he writes.

For the longer term, however, Hussman remains pessimistic. He notes that profit margins are at an extreme level and that he expects corporate profits to contract at a rate of somewhere between 5-15 percent annually over the next 3 to 4 years.

According to Hussman, one driver of falling corporate profits is a fall in the government's fiscal deficit. According to him, increases in the combined deficit of the government and household sectors lead to increases in corporate profits and vice versa. The former deficit has been declining recently, which does not augur well for corporate profits.

Indeed, a report from the Congressional Budget Office on Tuesday showed that the budget deficit is likely to shrink this year to its smallest size since 2008. It is seen falling to about 4 percent of GDP, compared with a peak of almost 10 percent in 2009.

Furthermore, the deficit is forecast to continue shrinking over the next few years, falling to 2 percent of GDP by 2015 before gradually rising again thereafter.

So if the stock market does experience a surge in coming weeks, Hussman thinks that it could turn out to be just a “speculative blowoff” that “would only make the subsequent completion of the present market cycle that much worse”.