Hussman still has modest exposure on the long side despite a host of negatives.
Says dollar no longer undervalued versus the Euro but still heavily undervalued versus the Asian currencies.
Market Climate
As of last week, the Market Climate for stocks remained characterized by unusually unfavorable valuations and still modestly favorable market action.
Several features of the current market environment are notable. Among the most important is valuation. The price/peak earnings multiple for the S&P 500 is about 20, compared with a historical norm of about 14, while the price/revenue multiple is about 1.5 and nearly twice its historical norm. I realize that some analysts are crowing about the “enormous free cash flow” coming out of S&P 500 companies, but those statements are poorly informed. Capital investment over the past 8 quarters barely matches depreciation, so there is zero net investment going on. Of course free cash flow numbers are going to be larger in that event, but it's ridiculous to assume that these companies will grow with zero net investment. So either the capital expenditure figure should be normalized higher, resulting in smaller valuation numbers on the basis of free cash flow, or the growth rates should be reduced, resulting in smaller valuation numbers on the basis of free cash flow. Gee, does it matter?
Still, overvaluation simply implies unsatisfactory long-term returns. It certainly doesn't necessarily inhibit short-term progress for the market provided investors are sufficiently willing to speculate (a willingness that we read out of the quality of market action).
It is important to note that market action remains modestly favorable, so we continue to carry a modest positive exposure to market fluctuations. Let me repeat that. We're still constructively positioned. At present, we've got a net positive exposure (largely through one-sided hedging rather than matched put/call combinations) of about 15% of portfolio value in the Strategic Growth Fund, with a sufficient number of call options to establish as much as 65% exposure to market fluctuations in the event of a substantial near-term advance. That's certainly not a forecast of an advancing market here, but I don't rule it out, and neither should you.
Bottom line – we've got poor valuations, insider selling picking up, excess bullishness from advisors (a contrary indicator) and a CBOE volatility index still reflecting unusual complacency (another factor in the decision to use directional hedges, since time premium is very cheap here), but still modestly favorable market action on our measures overall. This is an environment in which we want to defend against any sort of persistent decline that might occur, but in which we are still unwilling to completely hedge all market exposure away. Again, overall we remain modestly constructive in stocks – fully invested in a wide range of stocks, largely protected on the downside with put options, but only partially hedged with short call options so we retain our upside sensitivity to market movements, at fairly modest cost in terms of potential time decay.
In bonds, the Market Climate remains characterized by modestly unfavorable valuations and tenuously favorable market action. The Strategic Total Return Fund continues to carry an overall duration of just under 2 years (meaning that a 100 basis point move in interest rates would be expected to impact the Fund by about 2% on account of bond price fluctuations). We also continue to carry about 14% of assets in precious metals shares.
On a pure currency valuation basis using price/interest rate parities (see Valuing Foreign Currencies), I don't actually view the dollar as overvalued relative to most major currencies such as the euro, pound or Canadian dollar. The clear overvaluations are limited to the yen and of course the Chinese yuan. Still, at present, parity valuations aren't the only consideration. In order to even begin to adjust the current account deficit, the dollar will inevitably come under substantial pressure, and the dollar could easily push 15-20% through parity values regardless of the currency of reference. Suffice it to say, again, that aside from the yen and yuan, I don't view the dollar as materially overvalued on the basis of price/interest rate parities, but I'm as concerned as ever about a dollar crisis in the coming quarters. |
