... today from John Hussman ... note: for Hussman, this is unusually easy to understand ... some of the stuff he writes I clearly do not 'get', and do not even try ... in my experience, this is as precise and as clear as he gets ...
Ken Wilson
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Thursday Morning April 4, 2002 : Special Hotline Update
The Market Climate remains on a Warning condition. In all of the day to day volatility of the market, it's easy to forget that the current Climate is the most hostile we identify, and it warrants a fully hedged position. I try to be very careful in emphasizing that this is not a forecast, but the simple fact is that market risk currently carries neither investment merit nor speculative merit. This Climate doesn't rule out positive returns, but on average returns have been sharply negative. This set of conditions represents a small sliver of market history, but includes every historical crash of note. In short, the present Climate does not forecast a plunge to new lows, but such a plunge should not be ruled out in the weeks and months ahead. Until market action generates sufficient evidence of favorable trend uniformity, market risk simply is not worth taking. We remain fully hedged here.
It may seem almost picky to require favorable trend uniformity from a market is almost universally believed to have reached its low in September, in an economy that is almost universally believed to be in a recovery. But as I've noted before, bull and bear markets exist only in hindsight. Their existence cannot be confirmed or refuted in real-time. They don't exist in present, observable experience. What is absurd is the attempt to invest on the basis of what cannot be observed or confirmed except in hindsight.
In contrast, the dimensions that define the Market Climate are objective and observable. We know that when we look at past market cycles, the bulk of bull market periods have been accompanied by conditions of favorable trend uniformity, while the bulk of bear markets have been associated with conditions of unfavorable trend uniformity. We might do better by being invested only during bull markets and avoiding market risk only during bear markets, but these constructs are not observable. In other words, to invest based on hope or worry about bull market versus bear market is insane, unless those distinctions can be boiled down to criteria that are observable in real-time.
Likewise, the distinctions of recession versus expansion can only be made in hindsight. But we know that historically, when the economy has been in an expansion but both valuations and trend uniformity have been unfavorable, stocks have lost substantial ground. So the question of whether or not the economy remains in recession is irrelevant to our investment approach.
There is a strong statistical basis for our concern with trend uniformity. If the price of a stock declines, it may mean that the stock is a better value, or it may mean that investors know something unfavorable about the stock. The same is true for the market as a whole. The only way to "read" the information content of price action is if you have more than one price to analyze. When the action of two or more price series confirm each other, there is a good chance that there is a common factor driving both of them. When the movement in one price is not confirmed by another, there is a good chance that the movement is driven by uninformative noise.
As the reknown Dow Theorist William Peter Hamilton wrote in 1913, "A new low or a new high made by the one but not confirmed by the other is almost invariably deceptive. The reason is not far to seek. One group of securities acts upon the other... These independent movements, on previous experience, are usually deceptive, but when both averages advance or decline together the indication of a uniform market movement is good."
On the subject of Dow Theory, Richard Russell www.dowtheoryletters.com seems to be the only analyst writing about (and taking seriously) the divergence between the Dow Transports and the Industrials. Though we always defer to our own models, we take that divergence quite seriously as well, and it has widened to the point where a favorable confirmation in the near future is terribly unlikely. This fact is also important for its implications about the economy. As Hamilton wrote, "It seems a clear inference, in a movement where the averages do not confirm each other, that uncertainty still continues as concerns the business outlook..."
Our own measures of trend uniformity remain negative. The favorable breadth momentum off of the September low was also lost in late-December. So we simply have no reason to speculate on market risk, and with valuations extreme, there is certainly no reason to invest in it.
The bottom line is simple: we do not risk money on distinctions that are unobservable except in hindsight. Based on currently observable evidence, the Market Climate remains the most hostile we identify. We'll be quick to become constructive when and if the Climate improves, but at present, we remain fully hedged and defensive.
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