High Risk and Low Conviction

John P. Hussman, Ph.D.
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Since everyone is probably drowning in pre-election opinions, I decided that a brief comment focused on key considerations might be welcome. While the extent of the market retreat from the August peak has been quite shallow, a variety of short-term technical indicators appear “oversold” because the recent decline has breached the narrow trading range that has prevailed in recent months. From a cyclical perspective, however, the most historically reliable market valuation measures remain so extreme that a 40-55% loss in the S&P 500 would be only historically run-of-the-mill completion of this market cycle.

Short-term oversold conditions offer a sense of potential knee-jerk dip-buying behavior, but the conviction of that behavior is often fairly weak and short-lived. Meanwhile, extreme valuations imply the likelihood of steep market losses over the complete cycle, and also for poor S&P 500 total returns on a 10-12 year horizon, but valuations often have little effect on near-term market behavior. Instead, the behavior of the market over shorter segments of the cycle is driven not only by valuations but also by the preference of investors toward risk-seeking or risk-aversion. That’s really the aspect of present conditions that now gives extreme valuations their bite. Investor risk-preferences, as conveyed by the uniformity or divergence of market internals, are the hinge between overvaluation that persists and overvaluation that devolves into air pockets, free-falls, and crashes. Given that deteriorating market internals (particularly since mid-September) have continued to suggest increasing risk-aversion among investors, it’s not at all clear that short-term “oversold” measures will provide much support. For our part, we continue to classify market conditions among the most hostile market expected return/risk profiles we’ve identified across history. Regardless of the potential for a near-term “relief rally,” our defensive market view is likely to shift only as the combination of valuations and market action improve.

Last week, the S&P 500 retreated to its 200-day moving average. On one hand, this is a natural point for dip-buyers to offer support. On the other hand, a breach of that support would be an equally natural point that could trigger coordinated exit attempts by trend-followers. At the August peak (see Looking Ahead to a Bullish Outlook, and What Will Define It), I noted that the position of the S&P 500 relative to its 200-day moving average is not what defines favorable market action or our overall market return/risk classification. Indeed, once our estimated market return/risk profile is strictly negative (as it is at present), the negative implications for the S&P 500 aren’t affected by the position of the market relative to that average, except that the market tends to experience higher volatility once the market breaks that average. I observed, “The main reason to track the 200-day average here is because it is a widely-referenced trend-following pivot. A decline much more than 2% below that average could provoke coordinated exit attempts by trend-followers, at valuations nowhere near the point where value-conscious investors would be eager to absorb those shares.”

The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Please see periodic remarks on the Fund Notes and Commentary page for discussion relating specifically to the Hussman Funds and the investment positions of the Funds.

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The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse.

Prospectuses for the Hussman Strategic Growth Fund, the Hussman Strategic Total Return Fund, the Hussman Strategic International Fund, and the Hussman Strategic Dividend Value Fund, as well as Fund reports and other information, are available by clicking "The Funds" menu button from any page of this website.

Estimates of prospective return and risk for equities, bonds, and other financial markets are forward-looking statements based the analysis and reasonable beliefs of Hussman Strategic Advisors. They are not a guarantee of future performance, and are not indicative of the prospective returns of any of the Hussman Funds. Actual returns may differ substantially from the estimates provided. Estimates of prospective long-term returns for the S&P 500 reflect our standard valuation methodology, focusing on the relationship between current market prices and earnings, dividends and other fundamentals, adjusted for variability over the economic cycle (see for example Investment, Speculation, Valuation, and Tinker Bell, The Likely Range of Market Returns in the Coming Decade and Valuing the S&P 500 Using Forward Operating Earnings ).