John Hussman: Time to Reduce Our TIPS Position

Excerpt from the Hussman Funds' Weekly Market Comment (2/3/08):

[The] current economic downturn is likely to focus its damage on asset prices – the U.S. dollar, home values, low and mid-quality debt, and equity prices (largely through the combination of narrowing profit margins and lower valuations). In short, I expect that we are in the process of what might be called a “writeoff recession,” where significant amounts of asset value and perceived wealth will ultimately be written off. There will undoubtedly be some “wealth effects” on the real economy, but I would expect these to be only moderate.

Market Climate

As of last week, the Market Climate for stocks remained characterized by unfavorable valuations and unfavorable market action, holding the Strategic Growth Fund to a fully hedged investment position...

In bonds, yield levels have become somewhat compressed, finally prompting a reduction in our TIPS position to bring the overall duration of the Strategic Total Return Fund to about 1 year. The issue here is that inflation-protected securities are now so sought after that the economy would have to deliver long-term inflation of about 2.6% just to match the already depressed yields on long-term Treasuries... While it's rare that we invest in Treasury bills as a major asset class in the Strategic Total Return Fund, my impression is that a low, safe return is preferable to a low or negative speculative one.

Meanwhile, in precious metals, the Market Climate continues to be favorable, particularly with the specter of accelerated dollar weakness, but given that many of these stocks have become fairly overbought already, I clipped our precious metals position lightly toward 20% of assets in Strategic Total Return.