Excerpt from the Hussman Funds' Weekly Market Comment (2/9/09):
On Tuesday, the Treasury will announce how it plans to use the remaining $350 billion in TARP funds. Last week's market advance was largely based on Wall Street's hope that current mark-to-market rules will be abandoned or modified. This is like someone taking huge losses in their investment portfolio, and believing that not looking at the brokerage statement will improve their financial situation. Look, if the underlying assets are likely to regain value over a reasonable amount of time, then it might be appropriate to modify the capital accounting rules so temporary fluctuations don't drive banks into failure. But if you've got securities that are marked down to 20 or 30 cents on the dollar, and the underlying borrowers are likely to default because you haven't changed their payment obligations, failing to mark the portfolio to market simply allows banks to go quietly insolvent without the knowledge of the public. Providing federal insurance for those securities would amount to an open-ended, unlegislated, future bailout. Let's hope that isn't part of the plan.
I have absolutely no expectations relating to short-term market direction. It's quite possible that investors will be comforted by the Treasury's announcement on Tuesday, and that some early improvements in market action (particularly breadth) will extend further. The problem is that if we don't address foreclosure abatement in a major, deliberate way, whatever nascent recovery we might potentially get later this year will be cut short by a fresh round of foreclosures as we enter 2010.
From a valuation standpoint, I do believe that the stock market remains undervalued (though still far from the deep undervaluation we observed in say, 1974 or 1982). Accordingly, I do expect that passive, long-term investors are likely to achieve reasonably good market returns in the area of 10% annual total returns over the next 7-10 years. However, we have to be well aware of the tendency for weak markets to overshoot on the downside, so we continue to be unable to rule out even the 600 level on the S&P 500 as a possible (though not an expected or predicted) outcome during the next year or two.
I don't think one can be a good investor without being willing to increase one's exposure to market risk as valuations become more favorable and the expected return/risk profile of the market improves, so I expect that we will continue our practice of gradually increasing our market exposure on substantial weakness, and cutting it back on advances that fail to generate robust improvements in market internals. Still, it's important to recognize that the failure to address mortgage foreclosures has a cost, and will likely extend the recession and its effects on credit and capital formation. The longer our policy makers attempt to solve a deleveraging crisis by assisting lenders but failing to restructure the obligations of borrowers, the longer we can expect the current crisis to persist.