Hussman Funds - Weekly Market Comment_ A Textbook Pre-Crash Bubble - November 11, 2013.pdf

8/14/2019 Hussman Funds - Weekly Market Comment_ A Textbook Pre-Crash Bubble - November 11, 2013.pdf

1/5

Weekly Market Comment

Archive

Investment Research &

Insight Page

November 11, 2013

A Textbook Pre-Crash Bubble

John P. Hussman, Ph.D.

All rights reserved and actively enforced.Reprint Policy

Investors who believe that history has lessons to teach should take our present concerns with

but should also recognize that tendencies that repeatedly prove reliable over complete marke

sometimes defied over portions of those cycles. Meanwhile, investors who are convinced that

can ignore what follows. The primary reason not to listen to a word of it is that similar concern

late-2011, have been followed by yet further market gains. If one places full weight on this rec

weight on history, it follows that stocks can only advance forever.

What seems different this time, enough to revive the conclusion that this time is different, is f

Reserves policy of quantitative easing. Though quantitative easing has no mechanisticrelatio

prices except to make low-risk assets psychologically uncomfortable to hold, investors place f

the effectiveness of QE than can be demonstrated by either theory or evidence. The argumen

reduces to a claim that QE makes stocks go up because it just does. We doubt that the perc

Fed can hold stock prices up will be any more durable in the next couple of years than it was i

decline or the 2007-2009 decline both periods of persistent and aggressive Fed easing. Bu

like the internet bubble, novelty feeds imagination. Most of what investors believe about QE is

As Ray Dalio of Bridgwater recently observed, The dilemma the Fed faces now is that the to

disposal are pretty much used up. We think the question around the effectiveness of QE (and

which gets all the headlines) is the big deal. In other words, were not worried about whether thit or release the gas pedal, were worried about whether theres much gas left in the tank an

there isnt.

While we can make our case on the basis of fact, theory, data, history, and sometimes just ba

we cant do and havent done well is to disabuse perceptions. Beliefs are what they are, a

malleable as the minds that hold them. Like the nearly religious belief in the technology bubbl

boom, the housing bubble, and countless other bubbles across history, people are going to be

believe here until reality catches up in the most unpleasant way. The resilience of the market l

part of the reason investors keep holding and hoping all the way down. In this market cycle, a

cycles, few investors will be able to unload their holdings to the last of the greater fools just af

peak. Instead, most investors will hold all the way down, because even the initial decline will

question how much lower could it go? It has always been that way.

The problem with bubbles is that they force one to decide whether to look like an idiot before t

after the peak. Theres no calling the top, and most of the signals that have been most histori

purpose have been blaring red since late-2011.

As a result, the Shiller P/E (the S&P 500 divided by the 10-year average of inflation-adjusted

above 25, a level that prior to the late-1990s bubble was seen only in the three weeks prior to

Meanwhile, the price/revenue ratio of the S&P 500 is now double its pre-bubble norm, as is th

market capitalization to GDP. Indeed, the median price/revenue ratio of the S&P 500 is actuall

peak largely because small cap stocks were much more reasonably priced in 2000 than the

those better relative valuations prevented wicked losses in small caps during the 2000-2002 d

Despite the unusually extended period of speculation as a result of faith in quantitative easing

believe that normal historical regularities will exert themselves with a vengeance over the commarket cycle. Importantly, the market has now re-established the most hostile overvalued, ov

overbullish syndrome we identify. Outside of 2013, weve observed this syndrome at only 6 ot

August 1929 (followed by the 85% market decline of the Great Depression), November 1972 (

market plunge in excess of 50%), August 1987 (followed by a market crash in excess of 30%)

sman Funds - Weekly Market Comment: A Textbook Pre-Crash B... http://www.hussmanfunds.com/wmc/wmc131111.htm

5 11/14/2013 12:50 PM


2/5

(followed by a market plunge in excess of 50%), May 2007 (followed by a market plunge in ex

January 2011 (followed by a market decline limited to just under 20% as a result of central ba

These concerns are easily ignored since we also observed them at lower levels this year, bot

Reluctant Bears Guide to the Universe) and in May. Still, the fact is that this syndrome of overvalue

overbullish, rising-yield conditions has emerged near the most significant market peaks and

severe market declines in history:

1. S&P 500 Index overvalued, with the Shiller P/E (S&P 500 divided by the 10-year average o

earnings) greater than 18. The present multiple is actually 25.

2. S&P 500 Index overbought, with the index more than 7% above its 52-week smoothing, at l

4-year low, and within 3% of its upper Bollinger bands (2 standard deviations above the 20-pe

average) at daily, weekly, and monthly resolutions. Presently, the S&P 500 is either at or sligh

those bands.

3. Investor sentiment overbullish (Investors Intelligence), with the 2-week average of advisory bul

and bearishness below 28%. The most recent weekly figures were 55.2% vs. 15.6%. The sen

use for 1929 are imputed using the extent and volatility of prior market movements, which exp

amount of variation in investor sentiment over time.

4. Yields rising, with the 10-year Treasury yield higher than 6 months earlier.

The blue bars in the chart below depict the complete set of instances since 1970 when thesebeen observed.

Our investment approach remains to align our investment outlook with the prospective marketthat we estimate on the basis of prevailing conditions at each point in time. On that basis, the

hard-defensive, and any other stance is essentially speculative. Such speculation is fine with i

risk-limited positions (such as call options), but I strongly believe that investors with a horizon

years should limit their exposure to equities. At this horizon, even buy-and-hold strategies in


5 11/14/2013 12:50 PM


3/5

inappropriate except for a small fraction of assets. In general, the appropriate rule for setting i

exposure for passive investors is to align the duration of the asset portfolio with the duration o

liabilities. At a 2% dividend yield on the S&P 500, equities are effectively instruments with 50-

means that even stock holdings amounting to 10% of assets exhaust a 5-year duration. For m

material exposure to equities requires a very long investment horizon and a wholly passive vi

prospects.

Again, our approach is to align our outlook with the prospective return/risk profile we estimate

time. That places us in a defensive stance. Still, were quite aware of the tendency for investo

seemingly relentless speculation at the very peak of bull markets, and saw it happen in 2000our arguments for caution.

As something of an inoculation against this tendency, the chart below presents what we estim

optimistic pre-crash scenario for stocks. Though I dont believe that markets follow math, its

market action in recent years has followed a log-periodic bubble as described by Didier Sorn

Increasingly Immediate Impulses to Buy the Dip).

A log periodic pattern is essentially one where troughs occur at increasingly frequent and incr

intervals. As Sornette has demonstrated across numerous bubbles over history in a broad var

classes, adjacent troughs (say T1, T2, T3, etc) are often related to the crash date (the finite-ti

by a constant ratio: (Tc-T1)/(Tc-T2) = (Tc-T2)/(Tc-T3) and so forth, with the result that successi

closer and closer in time until the final blowoff occurs.

Frankly, I thought that this pattern was nearly exhausted in April or May of this year. But here

important here is that the only way to extend that finite-time singularity is for the advance to b

vertical and for periodic fluctuations to become even more closely spaced. Thats exactly wha

and the fidelity to the log-periodic pattern is almost creepy. At this point, the only way to exten

beyond the present date is to envision a nearly vertical pre-crash blowoff.

So lets do that. Not because we should expectit, and surely not because we should relyon it

should guard against it by envisioning the most optimistic (and equivalently, the worst case)

the essential caveat that we should neither expect, rely or be shocked by a further blowoff, th

depicts the market action that would be consistent with a Sornette bubble with the latest finite

that is consistent with market action since 2010.


5 11/14/2013 12:50 PM


4/5

To be very clear: conditions already allow a finite-time singularity at present, the scenario depi

most extreme case, it should not be expected or relied on, but we should also not be shocked

occurs.

Just a final note, which may or may not prove relevant in the weeks ahead: in August 2008, ju

market collapsed (see Nervous Bunny), I noted that increasing volatility of the market at 10-min

one of the more ominous features of market action. This sort of accelerating volatility at micro

related to log-periodicity, and occurs in a variety of contexts where theres a phase transition

another. Spin a quarter on the table and watch it closely. Youll notice that between the point

smoothly and the point it falls flat, it will start vibrating uncontrollably at increasingly rapid freq

phase transition. Again, I dont really believe that markets follow math to any great degree, bu

historical examples of log-periodic behavior and phase-transitions in market action that it helpthese regularities when they emerge.

Risk dominates. Hold tight.

The foregoing comments represent the general investment analysis and economic views of the Advis

solely for the purpose of information, instruction and discourse. Only comments in the Fund Notes s

specifically to the Hussman Funds and the investment positions of the Funds.

Fund Notes

As of last week, market conditions have re-established the most extreme overvalued, overbou

rising-yield condition we define. Despite a record of identifying the most extreme market peak

syndromes have been largely without consequence since late-2011. As investors who focus o

horizon, we continue to view these conditions with great concern, while recognizing that this rneed not end immediately.

Every market cycle produces conditions associated with very strongly favorable return/risk pr

conditions feature at least a moderate retreat in valuations followed by an early improvement i

Such conditions at the beginning of the bull market in early 2003 were essentially what allowe


5 11/14/2013 12:50 PM


5/5

majority of our hedges (despite valuations that were still fairly rich from a historical standpoint)

stress-test our return/risk estimation methods against Depression-era outcomes in 2009 and

anticipating and nicely navigating the 2007-2009 decline) forced us to miss that window in the

cycle, but I do not doubt that we will observe such conditions again and again in market cycle

I also do not doubt that well over half of the recent bull market advance will be surrendered ov

of this market cycle. I don't doubt it because that amount of surrendered progress is the norm

the-mill market cycles. It's a very bad thing, in my view, that investors have abandoned the se

valuations that exceed anything we observed prior to the late-1990s bubble, except for a few

peak. The belief of investors that they can get out en masse when QE ends, or at some otheruniversally anticipated exit point, is a fiction for which I cannot imagine a pleasant ending.

Strategic Growth Fund remains fully hedged, with a staggered strike position that places the

index put options a few percent below present market levels. Strategic International remains f

Strategic Dividend Value is hedged at about 50% of the value of its stock holdings. In Strategi

clipped our duration back to about 4 years about mid-week (meaning that a 100 basis point m

would be expected to impact Fund value by about 4% on the basis of bond price fluctuations).

holds about 5% of assets in precious metals shares and about 4% of assets in utility shares.

---

Prospectuses for the Hussman Strategic Growth Fund, the Hussman Strategic Total Return F

Strategic International Fund, and the Hussman Strategic Dividend Value Fund, as well as Funinformation, 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 fo

statements based the analysis and reasonable beliefs of Hussman Strategic Advisors. They a

of future performance, and are not indicative of the prospective returns of any of the Hussman

returns may differ substantially from the estimates provided. Estimates of prospective long-ter

S&P 500 reflect our standard valuation methodology, focusing on the relationship between cu

and earnings, dividends and other fundamentals, adjusted for variability over the economic cy

example Investment, Speculation, Valuation, and Tinker Bell, The Likely Range of Market Returns in the Co

Valuing the S&P 500 Using Forward Operating Earnings ).

Home | The Funds | Open an Account | Account Access | Research & Insight | Site Map

[Open Disclosure in Separate Window] Past performance does not ensure future results, and there is no assurance that the

Hussman Funds will achieve their investment objectives. An investor's shares, when redeemed, may be worth more or less

than their original cost. Current performance may be higher or lower than the performance quoted above. More current

performance data through the most recent month-end is available at www.hussmanfunds.com. Investors should consider the

investment objectives, risks, and charges and expenses of the Funds carefully before investing. For this and other

information, please obtain a Prospectus and read i t carefully.

The Hussman Funds have the ability to vary their exposure to market fluctuations depending on overall market conditions,

and they may not track movements in the overall stock and bond markets, particularly over the short-term. While the intent

of this strategy is long-term capital appreciation, total return, and protection of capital, the investment return and principal

value of each Fund may fluctuate or deviate from overall market returns to a greater degree than other funds that do not

employ these strategies. For example, if a Fund has taken a defensive posture and the market advances, the return toinvestors will be lower than if the portfolio had not been defensive. Alternatively, if a Fund has taken an aggressive posture,

For more information about investing in the Hussman Funds, please call us at

1-800-HUSSMAN (1-800-487-7626)513-326-3551 outside the United States

Site and site contents copyright 2003 Hussman Funds. Brief quotations including attribution and a direct link to this site (www.hussmanfunds.com) are

authorized. All other rights reserved and actively enforced. Extensive or unattributed reproduction of text or research findings are violations of copyright law.

Site design by 1WebsiteDesigners.


Hussman Funds - Weekly Market Comment_ A Textbook Pre-Crash Bubble - November 11, 2013.pdf

Documents

Transcript of Hussman Funds - Weekly Market Comment_ A Textbook Pre-Crash Bubble - November 11, 2013.pdf