The Government Deficits Land in the Deepest Pockets
Feb 2025 Market Comment from John Hussman
TLDR
John Hussman's February 2025 market commentary warns of extreme market valuations, unsustainable government deficits, and speculative excesses that mirror historical bubbles like 1929 and 2000.
Key takeaways:
• Market Valuations: The S&P 500's price/revenue ratio for the tech sector exceeds the 2000 peak, while the MarketCap/GVA ratio hits a record 3.6, signaling extreme overvaluation.
• Deficits and Wealth Inequality: Massive government deficits since 2016 have inflated corporate profits and household savings, disproportionately benefiting the wealthiest Americans.
• Recession Risks: The U.S. economy is running 2.7% above its sustainable potential, with warning signs like widening credit spreads and declining purchasing manager indices.
• Investment Strategy: Hussman remains defensive, emphasizing long-term forward spreads and 1-year moving averages to navigate potential market downturns.
Introduction
John Hussman's February 2025 market commentary, The Government Deficits Land in the Deepest Pockets, provides a sobering analysis of the U.S. economy and financial markets.
Hussman, a veteran investor and economist, warns of extreme market valuations, unsustainable government deficits, and speculative excesses that echo historical bubbles like 1929 and 2000.
This blog post breaks down Hussman's key arguments, offering actionable insights for investors and a deeper understanding of the economic forces at play.
Extreme Market Valuations
Record-Breaking Metrics
Hussman highlights several alarming valuation metrics:
• Price/Revenue Ratio: The S&P 500 Information Technology Index's price/revenue ratio stands at 9.9, surpassing the 2000 peak of 7.9.
This indicates extreme overvaluation in the tech sector, which has driven much of the market's recent gains.
• MarketCap/GVA Ratio: The ratio of nonfinancial market capitalization to gross value-added (GVA) has reached a record 3.6, exceeding both the 1929 and 2000 peaks.
Historically, such extremes have been followed by decades of subpar returns.
Historical Context
Hussman compares the current market to previous speculative bubbles:
• 1929 and 2000 Peaks: Both periods saw extreme valuations followed by severe market crashes.
The current MarketCap/GVA ratio of 3.6 suggests that the market is even more overvalued than during those periods.
• Long-Term Returns: Historically, when the MarketCap/GVA ratio exceeds 2.0, subsequent 10-12 year S&P 500 returns have averaged just 2-4% annually, far below the historical norm of 10%.
The Role of Government Deficits
Deficits and Surpluses
Hussman explains the accounting identity between government deficits and private sector surpluses:
• Government Deficits: Since 2016, the U.S. government has run massive deficits, totaling $12.7 trillion over eight years.
These deficits have been financed by issuing Treasury securities and newly created money.
• Private Sector Surpluses: Every dollar of government deficit corresponds to a dollar of surplus in the private sector (corporations, households, and foreign trading partners).
This surplus is held in the form of government liabilities, such as Treasury securities.
Wealth Inequality
The massive deficits have disproportionately benefited the wealthiest Americans:
• Corporate Profits: Corporate profits have surged, driven by government subsidies and tax cuts.
However, net business investment as a percentage of revenues has declined, indicating that these profits are not being reinvested in productive capacity.
• Household Savings: While household savings initially increased, much of this has been spent down, further boosting corporate profits.
• Wealth Concentration: The top 10% of Americans hold 67% of U.S. net worth, while the bottom 50% hold just 2.5%.
Similarly, the top 1% of income earners hold 50% of U.S. equities.
Recession Risks
Economic Overextension
The U.S. economy is running 2.7% above its sustainable potential, as estimated by the Congressional Budget Office (CBO).
This positive output gap is typical of late-stage economic expansions and often precedes recessions.
Warning Signs
Hussman identifies several indicators that suggest a recession may be imminent:
• Credit Spreads: Widening credit spreads, particularly for Baa-rated corporate bonds, signal increasing risk aversion.
• Purchasing Managers Index (PMI): A decline in the ISM Purchasing Managers Index below 50 would indicate contraction in the manufacturing sector.
• Job Growth: Slowing job growth, with the unemployment rate rising more than 0.3% above its 12-month low, would further signal economic weakness.
Recession Warning Composite
Hussman's Recession Warning Composite combines these indicators into a single measure.
While the composite is not yet signaling a recession, it is hovering near critical thresholds.
A 5% decline in the S&P 500, a 15 basis point widening in Baa credit spreads, and a 1-point drop in the PMI would trigger a recession warning.
Investment Strategy
Defensive Positioning
Hussman remains defensively positioned, citing extreme valuations, unfavorable market internals, and overextended conditions.
He emphasizes the importance of examining risk exposures and preparing for potential market losses well in excess of 50%.
Forward Spreads and Moving Averages
Hussman highlights the effectiveness of long-term forward spreads and 1-year moving averages in predicting recessions:
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Forward Spreads: Spreads like the 53-month forward rate minus the 1-month rate have historically been reliable predictors of economic downturns.
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Moving Averages: Applying a 1-year moving average to these spreads helps filter out noise and reduces false signals.
Market Internals
Hussman's proprietary measure of market internals tracks the uniformity of price action across thousands of individual stocks, sectors, and security types.
When market internals are unfavorable, as they are now, it suggests that speculative psychology is driving the market, increasing the risk of a sharp downturn.
Conclusion
A Call to Action
Hussman's commentary serves as a wake-up call for investors.
The combination of extreme valuations, unsustainable government deficits, and speculative excesses creates a precarious environment for financial markets.
While Hussman does not predict the exact timing of a market downturn, he emphasizes the importance of preparing for potential losses and aligning investment strategies with measurable, observable market conditions.
Final Thoughts
Hussman's analysis is rooted in historical precedent and economic fundamentals.
By focusing on long-term valuation metrics, government deficits, and recession warning indicators, investors can better navigate the challenges ahead.
As Hussman aptly puts it, "The era of relying on flawed yield curve spreads is over."
For the full analysis and methodology, refer to the original commentary: The Government Deficits Land in the Deepest Pockets.
Keywords: Market valuations, government deficits, wealth inequality, recession risks, investment strategy, forward spreads, moving averages.