John Hussman: Context Matters

Excerpt from the Hussman Funds' Weekly Market Comment (6/08/09):

The upshot of this is that we have repeatedly been both motivated buyers and motivated sellers near the 900 level on the S&P 500. Context matters – not simply price. Investing is largely a “signal extraction” problem where there is a certain amount of observable data, but where many of the things that matter are largely unobservable. For instance, when a stock price declines, it might be that the stock is a better value, or it might be that other informed investors anticipate negative long-term developments for the company which imply a substantial reduction in future cash flows, or it might be that investors are becoming generally skittish, and while the stock is not particularly mispriced, it may still be vulnerable to steep losses in the context of general investor fears. All of those factors are important – valuation measures, probable long-term cash flows, and risk aversion.

...

In January of this year, a fresh deterioration in market action was sufficient to prompt us to re-hedge the Strategic Growth Fund just about where the S&P 500 is at present. That shift helped us to avoid a great deal of discomfort, but aside from accumulating an “anti-hedge” in index call options, we did not take down our defenses at the March low. Subsequent market action has been of relatively poor quality more closely associated with bear market advances than with durable bulls, leaving our overall measures of market action still defensive, and there are profound economic problems that remain unresolved. So unlike 2003, we have not followed with a major removal of our hedges here.

It would be nice if oversold bounces were predictable, but unfortunately, oversold markets can become stunningly more oversold – as we saw in 2008. In hindsight, the advance since March has been strong, but not unusual in relation to the prior decline (where 25% -33% retracements of prior bear market losses have historically been standard). That retracement is largely behind us, and a variety of measures are clearly overbought here. With stocks no longer undervalued (except on measures that assume a return to 2007 profit margins), and subtle deterioration in some of our risk measures, any basis for accepting market exposure here is largely speculative.

...

Now, in the event of a 25-35% trading range – again a reasonable scenario in my view – then there will be bases from which to advance, as well as levels where we should be alert to the potential for fresh weakness. I noted last week, but should elaborate on – if the S&P 500 was to decline to the 700-800 level without a terrible breakdown in market internals, that area might be a potential base from which to advance, again within the context of a wide and extended trading range. On the other hand, if internals break down considerably, we could threaten or break the March lows. If internals improve sufficiently, we would establish a moderate amount of exposure through call options.

Comments

[Larry House:]

Thanks, John. I always get something from your posts. Be careful. You will be called a "fear-monger" or worse if you call this a bear market rally, which of course, it is.

Jun 09 01:45 PM

[Graham and ...:]

Dear Larry:

I was taught as a child to "tell the truth no matter whom it hurts."

In the end, calling this a bear market rally is more important than what anyone thinks today.

On Jun 09 01:45 PM Larry House wrote:

> Thanks, John. I always get something from your posts. Be careful.
> You will be called a "fear-monger" or worse if you call this a bear
> market rally, which of course, it is.

Jun 09 02:35 PM

[themackattack:]

Read this twice -- as far as I can see you said we could trade in a range, we could break down below March lows, or we could begin a steady rise. Apparently you will wait to see which is going to happen and then take a position to profit accordingly. We must be thankful that we have the ever-nebulous "market internals" to guide our decision making on this point...

Jun 09 08:24 PM

[John Galt:]

I believe that people often look at the market as an economic condition/indicator or at least to "confirm" their thoughts. In reality people are flooded with so much bullish/bearish sentiment from both sides they view even the short term market as the ultimate judge.

For example, if the macro economy stinks and the market is going down, people think that is bad, people sell, people are bearish, they easily see, listen to, and try and understand the problems.

When the economy is doing well and and the stock market is going up the average investor is more or less on auto pilot ( while traders are trying to earn big enough gains to retire).

Now we have the still have many of the economic indicators falling ( although at a slower rate) but the stock market has been constantly going up for 12 weeks... people see the market going up and they discount the " worst at a slower rate" economic indicators and they listen to our fearless government prognosticators try and talk up a recovery. Those same government officials that didn't see this crisis coming at all and denied denied denied it up until it was impossible to do so anymore.

My point is that if we had these same economic indicators but the market was crashing lower, people would have a totally different outlook on these "green shoots" and the economy as a whole. If the market was going down, instead of talking about " contraction at a slower rate", they'd be talking about "contraction".

The rising market is failing to make people question anything. It's like a "cure", get off my back, stop digging deep for the details, cool down that rage...

So here's my question to you all with the current logic...
Getting worse at a faster rate = bad ... right?
Getting worse at a slower rate now = good ... right?
So does getting worse at a constant rate = ok ?

Jun 09 10:06 PM

[Moon Kil Woong:]

Right now the crisis is not in the stock market. It's in the bond market. One crisis at a time please... the market will have to wait in line. As John Hussman mentions the markets move fore a variety of reasons. This one being skittishness for putting money into fixed rate investments. It has very little to do with fundamental values of the market or the individual stock and more to do with that will be a good inflation hedge.

If that's change you can believe in buy the bull.

Jun 10 01:08 AM