John Hussman: Preparing for Extreme Possibilities

Excerpt from the Hussman Funds' Weekly Market Comment (10/27/08):

The fact is that we can't rule out even extreme possibilities, such as a further drop in the S&P 500 by 30% to the 600 level. I absolutely do not expect the market to fall that much (particularly not in a single, uncorrected decline), but I can still tell you what we'll probably be doing if it does. At that point, I would expect to build up to a net investment exposure of at least 80%, without put option protection on that exposure, even if no aspects of market internals were favorable. I would view that allocation as conservative in view of those conditions. You can't manage risk effectively without contemplating extreme outcomes.

Still, even if this bear market is ultimately headed for a P/E of 7, a single one-way decline, uncorrected by a major rally, is extremely unlikely. Currently, the S&P 500 has declined by about 43% on a closing basis. In 1973-74, the market halted its overall decline at about 48%. Likewise in 1929, the market halted its initial decline at 48%, at which point stocks embarked on an advance of nearly 50% over the next 6 months before weakening again. Fear-mongerers like to point to the Great Depression, saying that an investor selling at the low in 1929 would have continued to lose until 1932, but they generally ignore the huge intermittent advances, and the fact that information accumulates slowly. Even in the worst of times, steep market declines tend to produce enormous (if ultimately impermanent) recoveries, as we saw even in the Depression.

To offer some additional context, Bill Hester put together the following charts. The first shows the extent and duration of every post-war bear market. The black line is the current decline, updated through Friday. Note that the worst of these were the 1973-74 bear and the 2000-2003 bear, both which terminated with losses of about 48%. Again, this is about the same loss as stocks experienced into their 1929 low, after which the market advanced by about 50% in the next 6 months.

Comments

[thedozer:]

paralysis by analysis

2008 Oct 28 05:57 PM

[Bullfighter:]

Blah blah blah......useless.

13 week ema needs to cross teh 34 week ema from under neath the 34.

Wake me when it's time to stop shorting.

2008 Oct 28 08:01 PM

[jr7107:]

Thanks Dr. Hussman, this is some of the best work on the street. I read the whole article, not just the excerpt.

Hooke's law, it felt a little like that today. Pure, unabated buying.

2008 Oct 28 09:58 PM

[nmelendez:]

...with no volume. That hollers to me "FALSE BOTTOM!!!!"

2008 Oct 28 10:05 PM

[nmelendez:]

Look, S&P should be at between 400 and 500 right now. Todays rally was nothing more than a bear market bull rally. If the S&P goes to 1130, get out, the next shoe is about to drop.

2008 Oct 28 10:15 PM

[MarvinMBA:]

Its too early in this cycle to second guess market direction....future quarters are going to show declines and no one can tell me how the market is going to react....my best guess is we have 2 years of volatility and more downdraft.
I think you will have to be very nimble to generate retirement bucks in this market...MarvinMBA

2008 Oct 28 11:13 PM

[MaverickBian:]

Today's rally, at best, would be short-lived.

Tons of bad news within next couple quarters from around the world would punch down S&P 500 to its new low.

More than one month money market freeze would no doubt have hurt a lot of businesses a lot, sure not reflected in this quarter but in next couple of quarters.

And housing downward trends are still intact, almost globally. If the housing market shed by another 15%, what would happen to all business investments and sonsumers spending? Try to think, if everyone's 401K shed by 30%~40%, and your house's value shrink on a monthly basis without end soon, then what would you as a consumer do? spending a lot or save a lot. No doubt much less spending, which ironically represents 2/3 of US GDP. From this perspective, you will see tons of very nasty numbers just like today's consumer confidence.

Another big concern would be higher and higher unemployment rate. If 1 million more lost their jobs at an average of annual compasation of 50K(some from very high paid industry like Wall Street), then consumers' spendings would have been hurt very much on an aggregate level.

Also, ironically, Naumuri saved Lehman Asia and MUFJ saved Morgan Stanley, but they need some super rich guys to save themselves if Neikki goes much deeper.

And most importantly, today's rally occurred only after 2:00pm with light volume. Sure, a lot of deep-pocketed guys like fund managers, in order to assure a big stampede, tried their best to build a mirage that bottom has reached. Personally, I deeply doubted it. Based on current tailspin speed, every quarter, S&P shed by 12%. If the recession will go deeper, which most analysts and economists have assured so, then we may see 600 as you first claimed in your article.

Anyway, be prepared for the raining days from now on unless you're pretty sure economy has turned around, which will be at least 2~3 quarters away.

2008 Oct 28 11:48 PM

[MaverickBian:]

BTW, if 30%~50% hedge funds went out of businesses, what would happen in the market place.

Today BP capital, which has built a very good history for the past decade, claimed more than 50% of its investors would redeem their money by year-end. So far, BP has lost more than 60%. So much liquidation by heavy-leveraged hedge funds within next 3~5 quarters would no doubt push down the broad market to the extreme.

2008 Oct 29 12:06 AM