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Dr. Hussmansuggests that holding interest rates at extremely low levels causes asset bubbles. How does that happen? Give examples.

Hussmansuggests that the stock market is highly valued and will thus earn low rates of return over the next 7 to 10 years. Explain his argument. Do you believe this?

Notes to the FOMC John Mauldin February 19, 2014 Options Email Print AddThis Sharing Buttons Share to FacebookShare to TwitterShare to LinkedInShare to Google+ Janet Yellen, the new Fed chair, has her admirers and her detractors. One unabashed admirer is my good friend David Zervos, Jefferies' chief market strategist, who during the past several months has taken to hollering "Dammit Janet, I love you!" He was at it again yesterday: Last week was certainly a week for the lovers. Q's broke to new cyclical highs, spoos moved to within just a few points of all time record highs, and Friday was St. Valentine's day! It was all about LOVE, LOVE and LOVE! But for those folks still hiding out in the HATER camp - those who probably spent Friday evening watching Blue Valentine, War of the Roses or Scenes from Marriage - last week must have felt more like a St Valentine's day massacre. These folks, and their econometrically deceitful overlay charts of 1927-1929 vs 2012-2014, were shredded by our new goddess of pleasure, beauty, love and of course easy money - Janet "Aphrodite" Yellen. She gave the haters a taste of the Hippolyos treatment!! And once again it was a triumph of love over hate!! Janet delivered the perfect message for markets. Her focus on underemployment was unquestionable. Her commitment to eradicate joblessness via the power of monetary policy was also unwavering. And for anyone who thought she would be hawkish, or even middle of the road, this speech was a wake up call. The reality is that we are dealing with a die-hard Keynesian dove! It's really not that complicated. That said some folks seem to think the rally was mostly a function of the data. Weak ISM, payrolls, retail sales and IP were apparently the drivers of a 5 percent rally off the lows. Pullease!! That is preposterous. The reality is the market was jittery (and downright freaky) into the Fed chairmanship transition. Risk was pared back by folks who began to incorrectly price in a surprise from Janet! And leverage induced illiquidity created an overshoot to the downside. Weak hands sold, and all the usual haters came out of their bunkers to once again warn of impending doom. But as per the norm, their day in the sun was short-lived. The dust has settled and the haters lost again! Love is in the air my friends, and we owe a great deal of thanks to our new goddess of easy money. Dammit Janet, I love you! Good luck trading. Take note of this phrase: "the new Goddess of Easy Money." It is now in the lexicon. I wonder how many virgins will be sacrificed to this new deity. (Just kidding, Janet!) Now, David is not above having a bit of fun in his always-entertaining commentaries, but for a somewhat more substantial take on the opening of the Yellen era, I suggest we turn to John Hussman. I wouldn't call John a Yellen detractor, exactly, but he is certainly inclined to take the Fed down a notch or three. Check out these zingers: While we all would like to see greater job creation and economic growth, there is little demonstrated cause-and-effect relationship between the Fed's actions and the outcomes it seeks, other than provoking speculation in risk-assets by depriving investors of safe yield.... [T]he "dual mandate" of the Federal Reserve is much like charging the National Weather Service to balance the frequency of sunshine versus rainfall.... The FOMC should be slow to conclude that monetary policy is what ended the credit crisis.... The philosophy seems to be "If an unprecedented amount of ineffective intervention is not sufficient, one must always do more." At present, U.S. equity valuations are about double their norms, based on historically reliable measures. The primary beneficiary of QE has been equity prices, where valuations are strenuously elevated. QE essentially robs the elderly and risk-averse of income, and encourages a speculative reach for yield. I think John would agree with me that the current economic theory driving our monetary policy is both inadequate and outdated. Is it any wonder that he concludes that monetary policy as it is practiced today is simply part of the problem? It is as if we are trying to fly a 747 using the knowledge and skills we learned while driving a car, and all the while looking in the rearview mirror. (Do those things have rearview mirrors?) You can find John's "Weekly Market Comment" and other valuable analysis at the Hussman Funds website. This weekend I will be writing about some of the recent analysis concerning income inequality. I've actually been thinking a lot about it in conjunction with the rise of the Age of Transformation. I think about it a lot, most personally in terms of my own seven kids. I'm not so concerned about income inequality as I am about income opportunity. It seems to me that we have an education system that was designed to meet the needs of the US and the Second Industrial Revolution that was grown atop the industrial British Empire. We are simply not preparing most of our children for the challenges that lie ahead. Many of course are going to do quite well, but that will be in spite of the educational process, not because of it. The complete higher-academic and bureaucratic capture of the educational process is as much at the root of income inequality as the other usual suspects are. There is more than one cause, and another root is the manipulation of capitalism and free markets by vested interests. But that's all too serious, because now it's time to hit the send button and think hard about an Italian dinner and the Miami Heat being in town. Even if Lebron James is on the other team, he is simply a pleasure to watch. Lebron, you should've come to Dallas to play with Dirk! Topping Patterns and the Proper Cause for Optimism John P. Hussman, Ph.D. All rights reserved and actively enforced. Reprint Policy Just a note - I'll be speaking at the Wine Country Conference in Sonoma, CA on May 1st & 2nd, 2014, along with Mike "Mish" Shedlock, David Stockman, Stephanie Pomboy, Steen Jakobsen, Chris Martenson, Mebane Faber, Jim Bruce and others. This year's conference will benefit highimpact programming for individuals on the autism spectrum and their families, primarily local efforts through the Autism Society of America. As many of you know, my 19-year old son JP has autism, so the cause is very close to my heart. Last year's conference benefited the Les Turner ALS Foundation. It's a great event in a beautiful location. Hope to see you there. For more information, please visit www.winecountryconference.com. Thanks - John Following a moderate decline from its recent highs, the market experienced a \"reflex\" advance last week. As I noted in the February 3 comment, \"Even the shallow 3% retreat from the market's all-time highs may be enough to prompt a reflexive 'buy-the-dip' response in the context of extreme bullish sentiment here, as the S&P 500 bounced off of a widely monitored and steeply ascending trendline last week that connects several short-term market lows over the past year. Regardless, the potential for short-term gains is overwhelmed by the risk of deep cyclical and secular losses. We presently estimate prospective 10-year S&P 500 nominal total returns averaging just 2.7% annually, with negative expected total returns on every horizon shorter than 7 years.\" Needless to say, our concerns are little changed by the last week's advance, and with this lowvolume reflex rally in place, we may observe a much deeper and uncorrected loss if the prior resolutions of severely overvalued, overbought, overbullish, rising-yield conditions are an indication. The expectation of impending market losses should certainly be tempered by the fact that similarly extreme conditions in February and May 2013 were largely uneventful, and were followed by further gains. Still, it's important to recognize that extreme syndromes of overvalued, overbought, overbullish, rising-yield conditions have previously created risk and instability over a period longer than a few weeks or even months. Likewise, in the context of log-periodic bubbles - as we've observed in U.S. equities since 2010 (see The Diva is Already Singing) - the \"critical point\" or \"finite time singularity\" is not a crash date, but the inflection point from self-reinforcing speculation to fragile instability. Didier Sornette observed this more than a decade ago in Why Stock Markets Crash. Our best estimate of that inflection point remains about January 13. It's also worth remembering that the \"catalysts\" associated with sharp market losses have often been fully recognized only after the fact, if at all. As Sornette emphasized, \"The collapse is fundamentally due to the unstable position; the instantaneous cause of the crash is secondary.\" The following chart is reprinted from our November 11, 2013 weekly comment A Textbook PreCrash Bubble. What is important, in my view, is not simply the log-periodic structure, but the broad array of additional classic speculative features that emerged as the market approached its recent highs. A few months ago, Bill Hester examined a century of price data, and observed that the nonoverlapping periods most closely correlated with the past 5-year trajectory of the S&P 500 were the advances preceding the 2007, 2000, 1987, 1937 and 1929 market peaks. This shouldn't be a surprise - the past 5-years have largely resembled a diagonal line, as did the advances to those extraordinary market peaks. Diagonal lines always have a nearly perfect correlation even if there is some amount of variation along the way. Again, we would dismiss historical analogs like this if the recent market peak did not feature the \"full catastrophe\" of textbook speculative features - particularly the same syndrome of extreme overvalued, overbought, overbullish, rising-yield conditions observed (prior to the past year) only at major market peaks in 2007, 2000, 1987, 1972, and 1929. The main temptation to ignore this concern is that similarly extreme conditions emerged in both February and May 2013 without consequence. Less extreme variants of this syndrome have also emerged periodically in the past few years (these variants also capture 1937 and a few other bull market peaks, as well as the April 2011 peak after which the market briefly retreated by nearly 20%). Overall, my view continues to be that the consequences of the more recent instances have not been avoided, but merely deferred - and those consequences will be worse for it. To offer some perspective of how major peaks have typically evolved, the following charts present the Dow Jones Industrial Average in the final advances toward, and the few weeks after, what turned out in hindsight to be major stock market peaks. For reference, let's examine the recent market peak. Notice several features: 1. A series of moderately spaced peaks forming a broad sideways \"consolidation\" over several months; 2. A breakout from that consolidation, leading to a steep and only briefly corrected speculative blowoff into the market's peak; 3. A steep initial selloff from the market peak, and finally; 4. A \"reflex\" rally (classically on low volume - indicative of a short-squeeze with sellers backing off) that retraces much of the initial selloff. One can observe that same general dynamic in the chart below - a series of moderately-spaced peaks forming a largely sideways consolidation, a breakout to a steep and only briefly corrected speculative \"blowoff\