John Hussman: Plunging Equity Valuations Should Impact Stock/Bond Allocation

Excerpt from the Hussman Funds' Weekly Market Comment (1/5/09):

While stock prices are now moderately undervalued, and are priced to deliver reasonably good returns over the coming decade (regardless of shorter-term prospects), Treasury bond prices are currently buoyed by such a “flight to safety” that they have ironically become speculative investments themselves... The long-term Treasury market now requires near-depression economic conditions to justify prevailing prices and yields-to-maturity. In the event that the general level of risk aversion among investors eases, either the U.S. Treasury market or the value of the U.S. dollar will endure disproportionately large losses...

With the recent surge in Treasury bond prices, the effective duration of a 30-year Treasury bond has climbed from just over 16 years to nearly 20 years. Meanwhile, the plunge in the stock market has collapsed the duration of the S&P 500 from nearly 60 years to just about 30 today. For investors who rebalance their portfolios annually, this is essential information. Given the probable long-term returns that stocks and Treasury bonds are priced to deliver, an investor seeking a 7% long-term total return would currently require an allocation of about 60% in stocks and 17% in bonds, for an overall portfolio duration of about 21 years – only a third of the duration that an investor seeking that same long-term return would have had to accept just 15 months ago!...

Investors are sometimes urged to allocate a percentage of assets to stocks equal to 100 minus their age. In my view, this formula is terribly crude, because it ignores the impact of valuation on the duration of stocks... Given current valuations, the appropriate allocation – again for a passive investor with a 20-year horizon – could be as high as 58% in stocks, provided that the remainder of the portfolio is in fairly short-duration, low-volatility securities.

Comments

[Archman Inv...:]

Memo's, articles, etc from Asset gathering Fund managers are self serving to say the least.
Though I have to give kudos to Mr. Hussman, for protecting his fund holders better than 99% of other asset gatherers.

Treasuries are in a bubble.

No question about that, however bubbles can go on a lot longer than people think. (Gosh, how many times have we heard that phrase before? Ha, Ha)

S & P 500, 25 year continuation trend line puts the index at 750 as of today's date. Within 50 points of the trend would seem a reasonable place to invest for the long term. Any investment outside the trend takes on more risk.

S & P 500 as of today is at 927. Once again, our happily Fed/Treasury and it's partner trading desks couldn't let the S & P 500 revert to the mean. They had to get it going with a low volume rally since late November. History has shown that low volume rallies, while lasting quite awhile, always fail.

If you are a trader, you have to love this action. You will have a great opportunity to short the market, probably over the late summer into early fall, as the market once again gives up the ghost and reverts back down to that 25 year trend line.

Maybe then the Fed/Gov't will stay out of the market and let the market return 10% / year (div included) for the next 20 years, instead of up 30%, down 15%, up 20%, down 35%, etc.

Wouldn't that be nice for a change??

Jan 06 07:19 AM

[investor88:]

There is a case for some long term investments.

Jan 06 07:24 AM

[1977°C:]

Buy bonds, markets will deliver s..t in the next 10 to 30 years, buy in small portions long dated treasuries till you retire, if you retire in less than 10 years and your investment is mostly stocks, then let me tell you - in 10 years you are almost bankrupt.
I please all stay away from stocks as an asset class indefinitely, if you are not hedged with double short index ETF or other short index instruments, keep away from it alltogether.We are heading for 3000-4000 Dow Jones at some point in the next 10 years.

Jan 06 11:15 AM

[Ebi:]

Why go for equity now when high-grade corporate bonds offer "equity-like" return and the equity market is yet to bottom out?

Jan 06 04:20 PM

[dawase@gmai...:]

A 20 year horizon and you assume you won't need to invade the principal, ie. you won't lose your job. Sounds like I'd like to be that person.

Generally speaking I think Cramer is a goof, but on Oct. 6 he told everyone to sell whatever they would need for the next five years. Pretty good advice in retrospect.

Long term allocation models aren't that useful in highly volatile economies. Unless you're on the Forbes list or something... Not like I'd know.

Jan 07 12:05 AM