Excerpt from the Hussman Funds' Weekly Market Comment (5/4/09):
In his book On Being Certain, neurologist Robert A. Burton quotes F. Scott Fitzgerald – “The test of a first rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function.” Buddhist teacher Pema Chodron calls it “being comfortable with uncertainty” – being willing to take every aspect of reality as the starting point, without wasting energy wishing things were different, without denying reality as it is (even if your next step is to work toward changing things), and without needing to know what will happen in the future. “The truth you believe and cling to makes you unavailable to hear anything new. The best thing we can do for ourselves is to be open to an unknown future.”
Burton offers the same advice. Tolerating the unpleasantness of uncertainty, he writes, “is the only practical alternative to cognitive dissonance, where one set of values overrides otherwise convincing contrary evidence. Each position has its own risks and rewards; both need to be considered and balanced within the overarching mandate: Above all, do no harm. Science has given us the language and tools of probabilities. We have methods for analyzing and ranking opinion according to their likelihood of correctness. That is enough. We do not need and cannot afford the catastrophes born out of a belief in certainty.”
Meanwhile, market action in recent weeks has been excellent from the standpoint of breadth (advances versus declines), uneven from the standpoint of leadership (where much of the strength has been focused on speculation in companies with extraordinarily poor balance sheets), and rather uninspiring on the basis of trading volume.
From an economic standpoint, the main argument for an oncoming recovery is simply that the knuckles of investors and consumers are no longer absolutely white. A backing-off from extreme risk aversion is certainly helpful, since it puts banks at less risk of customer flight, but the underlying assets of banks are still deteriorating. For the time being, the recent revision in accounting rules has prevented balance sheets from showing negative capital and revealing insolvency, but the reality is that the mortgages underlying bank assets are still defaulting. If this was simply a temporary problem of fluctuating asset values that would recover over time, the problem would not be serious. As T. Boone Pickens once said, “I have been broke three or four times, but fortunately for me I'm not an MBA, so I didn't know I was broke.” But the assets Pickens owned moved in cycles, and regularly recovered in step with the price of oil. In the case of mortgages, once the loan goes into foreclosure, there's an asset sale, the loss is taken, and the game is over.
Overall, then, the fundamentals of the market and the economy are not nearly as positive as they are being spun by analysts. Stocks are at best only moderately undervalued if one assumes that profit margins will recover to the historical extremes we saw in 2007, and are otherwise mildly overvalued. The financial system is in cosmetic remission, looking better on the surface, but still deteriorating internally. Still, we can't discard the fact that the extreme risk aversion of recent months has eased. Breadth has been quite strong, but is also overbought (with over 80% of stocks above their 20-day and 50-day averages). The mixed picture offers neither certainty that the bear market will resume, nor that a bull market will emerge.