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Excerpt from the Hussman Funds' Weekly Market Comment (11/03/08):

While many investors appear frantic about the market's recent losses, and are extrapolating that fear into visions of economic Armageddon, I have to say that I'm more comfortable with the market's valuation here than I've been in about 15 years. As for the economy, this downturn is something we anticipated and understand. The lingering question what sort of policy response we'll see in relation to foreclosures, which will affect the depth and duration of this recession.

After more than a decade of “outlier” valuations, stock prices are finally back to a historically normal, even favorable, relationship with probable long-term cash flows. Note that long-term cash flows often have little to do with near-term earnings. Stocks shouldn't be priced based on this year's or next year's earnings, unless those earnings reflect normal profit margins and business conditions.

Frankly, I haven't enjoyed the market's behavior in recent years at all, because the stocks that were embraced by investors – first the high debt, low quality garbage and then the industrial and commodity stocks – consistently struck me as speculations rather than investment values. I try to ensure that the net asset value of the Fund is “backed” by a reasonably priced stream of long-term corporate cash flows; in other words, by stocks that have stable long-term cash flows and appear to be undervalued, on average. I had a very open aversion to “holding my nose and buying garbage,” so we didn't “ride” those speculative stocks higher. Of course, Strategic Growth doesn't establish net short positions or sell short individual stocks (which I continue to believe is an appropriate policy for an equity growth fund), so we didn't gain from their subsequent collapse either. All of that made for a somewhat frustrating cycle.

Rich market valuations also posed challenges in recent years, because they held us to a far more hedged investment stance than I would have preferred. As I wrote in the 2006 Hussman Funds Annual Report, “ It is important for shareholders to recognize that the relatively defensive position of the Strategic Growth Fund since its inception is not typical, nor is it preferable as a “standard” investment stance. Historically, these have been periods in which stock market risk has been well worth taking. In a normal market cycle with appropriate valuations, not only would the S&P 500 typically achieve higher returns, but the Strategic Growth Fund would also typically accept greater levels of market risk. While the Fund has achieved strong returns given the constraints of rich valuations since 2000, these valuations have held back the performance of the major stock indices, as well as the flexibility to accept risk that the Strategic Growth Fund would have under typical valuation conditions.”

Source: John Hussman: Value Dinosaurs