Hi Robert,
The following comments are from Hussman Economics.
The Market Climate remains characterized by extremely unfavorable valuations and unfavorable trend
uniformity. Keep in mind that our measures of trend
uniformity are concerned not simply with the trend of major indices but with the behavior of risk
premiums. Favorable trend uniformity is a signal that
investors have a robust preference to take on market risk, and it is that which has historically allowed
overvalued markets to become more overvalued.
Overvalued markets lacking favorable trend uniformity have historically generated a wide range of short
term returns (both positive and negative), but a poor
average return. In other words, high volatility and low expected return. We avoid market risk in those
situations. Understand though, that the current Climate
allows both positive and negative returns. The difference we have with market timers is that once we
identify the prevailing Market Climate, we don't believe
that it is possible to forecast returns within that Climate. In short, the recent rally is completely consistent
with an unfavorable Market Climate - one which
we have no intent of "playing." We have been carrying a very modest net long position during most of the
recent rally, but that stance has typically left less
than 15% of our stock portfolio unhedged. That's about as constructive as the data have allowed us to
become.
Overvaluation, even with unfavorable trend uniformity, does not typically lead to market crashes.
Historically, market crashes have always required one
additional element: rising yield trends, particularly in bonds and utilities. That element has been missing
from market action in recent months. Unfortunately,
bond and utility yields have been pressured higher in recent weeks. As a result, we may very well move to
a Crash Warning in the weeks ahead, which always
warrants a fully hedged portfolio. For now, however, we remain in a defensive but very slightly unhedged
position.
As you know, I am a strong adherent of the view that market action conveys information. But I'm also a
strong adherent of research. What I find
frustrating is the relentless parade of amateurs offering interpretations of stock and bond market action,
without having the faintest idea of what they are
talking about.
Another note to CNBC anchors: next time your guests wax rhapsodic about how the recent increase in
bond yields signals an economic upturn ahead, ask
them this. In the 6 months prior to the past 5 recession lows, how much have long-term interest rates
risen in anticipation? They didn't. Bond yields fell every
time, by nearly 1/2% on average. Indeed, in the 27 recessions since 1871, there is not a single instance
when bond yields rose strongly in anticipation of a
recovery. Indeed, even though yields have increased slightly on average in the months following a
recession low, this tendency is not statistically significant.
Yields are as likely to fall as they are to rise. And as a side note, the rate of inflation in the 6 months after a
recession low has always been even smaller than
the rate of inflation in the 6 months prior to that low.
The recent selloff in bond prices and the increase in yields is simply not evidence of a coming economic
turn. You may recall that I advised locking in
mortgage rates several weeks ago at their lows. The reason had nothing to do with expectations of an
economic turn. Rather, bond prices had become
overextended in an unsustainable flight to safety. Their yields had become, in my analysis, too low to
properly compensate for maturity risk (the risk of price
fluctuations in response to changes in interest rates). Evidently, the bond market agreed. The recent plunge
in bond prices reflects nothing more than a
normalization of risk premiums. There is no information about economic prospects contained in that
action.
The interpretation of the recent stock market advance as evidence of recovery also comes as news to
analysts who actually do careful research. One of these is
Lakshman Achuthan of the Economic Cycle Research Institute, who notes that while most people seem to
think that the stock market bottoms six months
before economic turns, 50% of the time in the post-war era the lead has been four months, 25% of the
time it's been five months and 25% of the time it's been
three months (click here for full article). So if the September low was the real thing, then the economic
rebound has to start by February. The only basis for
such an expectation would be a naive reliance on the average 11-month duration of post-war recessions,
without any examination of additional data.
Yet on a closer inspection of this data, even if the current downturn followed the pattern of relatively mild
post-WWII recessions, this recession would end in
July or August 2002 (click here for further NBER analysis). Indeed, Dr. Robert Hall, the chair of the
NBER Business Cycle Dating Committee (and a
member of my dissertation committee at Stanford) offered the same suggestion in a recent press
conference. Achuthan notes that such a recovery date would
set a bear market low between February and April 2002, at levels below what we saw in September.
Now combine these facts with others. Consider the fact that sustainable bull markets following recessions
have begun from price/peak-earnings ratios below
10 and never above 14 (the current ratio is 22). Consider the fact that the percentage of bearish investment
advisors has always been between 55-70% at
post-recession market troughs (the current percentage is 27% bears, and never moved beyond 43% even
at the September lows). In my view, a sustained bull
move here seems extremely improbable.
As I always note, favorable trend uniformity here would generate a modest amount of speculative merit,
and we would remove a portion of our hedges as a
result, regardless of my personal views. But nothing short of a major stock market decline would give
stocks investment merit here. All of the analysis above
is intended to provide background and context - to place the day to day flow of information (and
disinformation) in perspective. But in the end, we are
defensive not based on forecasts about the future, but based on the identifiable present. We continue to
identify a hostile Market Climate here, and we remain
defensive for now. |
