Monday, May 2, 2011

Hussman Weekly Market Comment: Extreme Conditions and Typical Outcomes

Given the extraordinary fiscal and monetary indulgence that has been heaped upon the economy in recent years, it is tempting to believe that the world has changed in ways that make structured, historical, value-based analysis inappropriate. But in my view, this gives far too much long-term credit to short-term phenomena. It's certainly true that we ought to adapt to the possibility that valuation "norms" will be higher (and long-term return expectations will be lower) in the face of persistent policy efforts to elevate asset prices and foment bubbles. Still, our estimates of expected market returns have remained very accurate even in the most recent decade, so the lesson is not that valuations don't matter, or that 2+2 no longer equals 4 (our long-term return estimates are essentially basic algebra), but rather that policy makers may engender higher valuations and lower long-term return prospects more frequently in the years ahead than they have in the past.

All of that said, our defensiveness since April 2010 remains consistent with evidence from both post-war and Depression era data. I emphatically believe that quantitative easing is a reckless and misguided policy, and should not be relied on as a durable basis for speculation. It is also clear that the syndrome of overvalued, overbought, overbullish, rising-yields conditions typically leads to tears, on average, regardless of the subset of historical data one chooses to analyze. Despite what, in hindsight, were missed opportunities to accept market risk in 2009 and early 2010, now is not then. Conditions are far different, and far more hostile. Though the difficult lessons of the recent cycle have been the source of frustration, those lessons are also the basis of my belief that we are well-equipped to navigate future opportunities and threats to an even greater extent than we were prior to the crisis. Those opportunities and threats are inherent in an incompletely resolved credit picture, untenable extremes in fiscal and monetary policy, and what is - in contrast to early 2009 - a strenuously overvalued, overbought and overbullish equity market.