John Hussman: Market Moves to the Risk Sectors

Excerpt from the Hussman Funds' Weekly Market Comment (4/21/08):

Last week largely represented an unwinding of the “defensive trade” as investors embraced the "risk trade" instead – Treasury bond prices dropped sharply, and consumer staples and a number of other defensive sectors were down or relatively unchanged, even as financials and materials gained strength.

The pullback in the Strategic Growth Fund last week (-1.87%) was primarily attributable to those divergent industry returns, away from defensive sectors (staples, non-cyclicals, healthcare, etc) and toward risk sectors (financials, materials, cyclicals, internet) not heavily represented in the Fund.

We are intentionally avoiding such risk sectors on the expectation of further financial sector weakness, and because materials and cyclical stocks currently rely on sustained commodity price strength and “decoupling” between the U.S. and foreign countries. I continue to view commodities as cyclical, and decoupling as implausible – indeed, my impression is that the commodity surge will likely be turned on its head within a few months, about the point where 10-year Treasury yields move above the year-over-year CPI inflation rate...

The market is again overbought in a still-unfavorable Market Climate, so I don't expect perceptions about economic, financial and earnings risk to remain suppressed for long. Still, we are always open to new evidence, and do not rule out a more constructive position if convincing evidence arrives. Although we still require improved market internals to warrant a speculative exposure to market risk, I would expect to remove a portion of our short call hedges if we observe sufficient follow-through in market internals.

Editor's note: Relevant sector ETFs include the iShares Dow Jones U.S. Basic Materials Sector Index Fund ETF (IYM), iShares Dow Jones U.S. Financial Services Index Fund ETF (IYG), Internet Architecture HOLDRs (IAH), Internet Infrastructure HOLDRs (IIH), and Materials Select Sector SPDR ETF (XLB). See also the full list of sector ETFs.