This week we feature John Hussman’s article, A Who’s Who of Awful Times to Invest. The author, John Hussman, manages the Hussman Strategic Growth Fund and the Hussman Strategic Total Return Fund, between which he is almost fully invested personally. The total return since inception of the Strategic Growth Fund (NASDAQ: HSGFX) can be seen below:
Hussman’s funds take risk in two ways. First, they buy/short US equities that they think will outperform/underperform. The fund’s top ten holdings are as follows:
Top 10 Holdings
source: http://finance.google.com/finance?q=HSGFX
The second way the fund takes risk is by varying it’s exposure to the overall market. When the fund is “fully hedged”, the fund should not lose or gain value from an overall market movement. When the fund (or some fraction of the fund) is unhedged, the fund’s value is affected by overall market moves. Hussman varies the fund’s exposure based on a “Market Climate” assessment, which includes measures of valuation and short-term market movements.
Essentially, the fund takes more market risk when conditions match historically good times to do so and takes less market risk when conditions match historical times when risk has not paid off.
Hussman has a Ph.D. in Economics from Stanford and was a professor at U Michigan for a while (that’s probably why I like him). In addition to managing his funds, he writes a weekly column that I’ve been reading for about 6 months now. He’s been trying to tell people that the U.S. stock market is overvalued for some time. At the present, his funds are fully hedged, meaning that Hussman does not want to take *any* market risk. The hedging has cost his shareholders a bit in the short run, but his analysis claims that the stock market gains of late are not worth the market risk.
His article, A Who’s Who of Awful Times to Invest, compares today’s market conditions with 7 previous market times:
December 1961 (followed by 28% market loss over 6 months)
January 1973 (followed by a 48% collapse over the following 20 months)
August 1987 (followed by a 34% plunge over the following 3 months)
July 1998 (followed abruptly by an 18% loss over the following 3 months)
July 1999 (followed by a 12% loss over the following 3 months)
December 1999 (followed by a 9% loss over the following 2 months)
March 2000 (followed by a 49% collapse in the S&P over the following 30 months)
The defining characteristics of these instances were:
1) price/peak-earnings multiple above 18
2) 4-year high in the S&P 500 index (on a weekly closing basis)
3) S&P 500 8% or more above its 52-week moving average (exponential)
4) rising Treasury and corporate bond yields
Depending on how we define the interest rate trends, we can include two additional historical instances of these conditions: October 1963 and May 1996, both closely followed by 7-10% corrections.
One more instance completes the list: July 2007.
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The article doesn’t claim to be calling a market top or trying to predict the short-term future. But he is claiming that the stock market has historically performed terribly when market conditions look like they do today. And that’s the important take-away.
Here is a key passage:
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In any event, the fact is that current conditions fall into a fairly narrow sliver of historical experience, but one that has enough observations to draw clear conclusions. That conclusion is that overvalued, overbought, overbullish conditions (even short of the unusually extreme ones listed above) have resulted in market returns below Treasury bill yields, on average. Our strategy is not to try to predict whether the current instance will be different. To admit that there is risk is to admit that there is a range of possible returns, some better than the average, some worse. But an average outcome below Treasury bill yields, and risk to boot, is not a good combination. Consistently taking risk in such environments provides no long-term edge, only volatility.
Our strategy is to align ourselves with the prevailing return/risk profile of the market, knowing that there will be many, many attractive periods in which to accept market risk, and that these periods have historically provided more than enough opportunity to capture strong returns over the full cycle, with subdued risk (see the remarks of recent weeks for some instructive examples).
Frankly, I don’t know whether investors will drive the market even higher in the weeks ahead. My opinion is that whatever gains emerge (and indeed, much of what has already emerged) will ultimately prove quite temporary. What I do know is that certain factors have reliably identified egregiously bad times to accept market risk, and that every historical instance similar to the present has been a disaster. The current instance may very well prove to be the exception, but I do not invest shareholder assets on the hope that the future will be entirely at odds with all available historical evidence.
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Then again, Hussman and I probably have too “academic” an outlook for the stock market anyway…<sigh>.
– defo
