Monday, September 27, 2010

Hussman Weekly Market Comment: Not Yet Out of the Woods

Given the data in hand, it's clear that past growth downturns of the same extent have often gone on to become recessions. However, there are a few exceptions where these growth rates dipped below zero and then recovered. If we had good reason to expect positive economic tailwinds, we would be less concerned about the present deterioration. Unfortunately, my impression is that the bulk of the growth that we did observe coming off of the June 2009 economic low was driven by a burst of stimulus spending coupled with a variety of programs to pull economic activity forward. My concern is that these synthetic factors are now trailing off, with little intrinsic economic activity to carry a recovery forward.

Suffice it to say that we're not yet out of the woods.


Our investment strategy is a long term one. We don't rely on being "right" about individual instances. Rather, we focus on average outcomes, taking greater exposure to risk in conditions that have historically been associated with favorable returns and taking less risk in conditions that have historically been associated with weak returns - on average. The present overall return-to-risk profile is not favorable, on average. But again, despite our present defensive position, we would prefer - hands down - to be wrong about oncoming economic weakness. In our view the market is already fully priced for an economic recovery anyway, so the challenges are steep for investors even without a further downturn.

As I've noted before, risk management is forgiving. During the past decade of rich valuations, and based on our analysis, throughout history, the temporary returns that investors have missed during periods of hostile valuations and overbought conditions have been more than compensated by the avoidance of subsequent - often profound - losses that correct those valuations. But this is a long term, average tendency. We aren't market timers - we are risk managers. For now, conditions continue to stack on the defensive side.