John Hussman: A Brief Primer On The European Crisis

Includes: EWP, FXE, GREK
by: John Hussman

Excerpt from the Hussman Funds' Weekly Market Comment (6/18/12):

With Greek elections resulting in a fairly benign outcome that promises to hold the euro together in the near-term, the market may enjoy some amount of relief. The extent and duration of that relief will be informative. Based on broader factors, we don't expect that relief to survive very long, but we are willing to respond more constructively if our own return/risk measures become more favorable.

Our estimate of the prospective return/risk tradeoff in the stock market remains in the most negative 0.5% of historical instances. That said - and this is important - if market internals improve meaningfully over the next few weeks (measured across individual stocks, industries, sectors and security types), our estimate of the market's prospective return/risk profile would improve, despite what we view as rich valuations and a new recession. Very roughly speaking, this would require a solid rebound in market internals over a period of 2 or 3 weeks. That sort of outcome might accompany a Fed easing or other event, but our focus is on the measurable condition of market internals, not on Fed policy or other news per se. A positive shift in our measures of market action would likely be enough to ease back from our tightly hedged investment stance to a slightly constructive position. For now, we don't have the evidence to take anything but a very defensive stance, but we'll take changes in the evidence as they arrive.


The global economy remains in a deleveraging phase - the difficult portion of what is known as the "financial cycle" - in the aftermath of a long period of excessive debt expansion and credit growth. Meanwhile, by our analysis, the U.S. has also now entered a recession in the business cycle (particularly based on what we infer from unobserved components methods, and also evidenced by observable factors such as weak growth in consumption and income, a dropoff in new orders and industrial production, an acceleration of negative surprises on short-leading indicators such as Fed surveys, and now even softness in short-lagging data such as new unemployment claims).


The upshot is that we continue to view market conditions as being among the most negative 0.5% of historical instances. Our analysis suggests that the U.S. has entered a new recession. Still, there is a significant prospect of further monetary interventions, and while we don't expect much of durable benefit from that, our focus is squarely on our own measures of market action. To the extent that we see material improvements in those measures, we would be inclined to ease our presently defensive position. My impression is that further Fed easing will be relatively weak and surprisingly poorly received by the market, but in the event our own metrics improve materially, we would respond with a more constructive stance. For now, we remain tightly defensive, and believe that the headwinds remain unusually strong.

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