John Hussman growing more cautious on stocks (but still somewhat bullish) and more positive on bonds
"The Market Climate for stocks remains characterized by unfavorable valuations and moderately favorable trend uniformity. This places us in a constructive position, with a range of 30-50% of our stock holdings hedged against the impact of market fluctuations. Still, we remain positioned to benefit from market advances here.
We continue to observe a range of breakdowns in market action, the most obvious being on the interest rate front, and extending to a wider set of market internals. Recent advances, for example, have tended to display dull or diminishing volume, while new lows have persistently expanded on market declines. The response to good economic news has also been curiously muted. So while the overall pattern of market action continues to indicate a preference of investors to accept risk, we're also seeing a tendency for investors to become more selective. In an overvalued market, this warrants some level of reserve. Our current position has enough market exposure to participate in any continued advance, while also responding to moderately heightened risks.
Meanwhile in the precious metals markets, conditions remain favorable overall as well, but strength in several of our holdings in combination with a moderate weakening of underlying conditions prompted us to reduce our gold and precious metals holdings in both Strategic Growth and Strategic Total Return last week.
In bonds, the Market Climate has shifted to decidedly improved condition; moderately favorable valuation, and moderately favorable trend uniformity. This shift in Market Climate warrants a shift toward long maturity bonds. We shifted approximately 20% of the Strategic Total Return Fund to long Treasury bonds on Friday. This isn't an aggressive position, but it is measurably more constructive than we've been carrying.
It is important to interpret this shift properly. It would be incorrect to infer that we have become "bullish" on bonds, that we believe the bond market has turned, or that we are forecasting a bond market rally. We don't require such specific forecasts. Very simply, we believe that the average return/risk characteristics of the bond market have changed. Our goal is to allocate risk in proportion to the return/risk characteristics of each Climate we identify. Changes in Market Climate, which prompt changes in our investment exposure, may have the appearance of "calls" on market direction, but such an appearance is unintentional. We make absolutely no attempt to "call" rallies, declines, bottoms or tops.
Think about it this way. The Market Climates we identify are based on observable conditions. Based on these conditions, we can identify the Market Climate that existed at any particular point in history. If we gather up all the periods that fall into a given Climate, we get set of "bell curves" or "probability distributions." Every Climate includes advances, declines, and neutral periods. But the average return/risk characteristics vary significantly. It's those average characteristics that drive our positions. Once we identify a particular Climate, however, we have absolutely no ability to forecast whether the next draw from the distribution will be positive or negative. Also, since there is no stable "transition probability" to help forecast when one Market Climate might shift to another, it is useless to attempt forecasts over any extended period of time. Our willingness to act on the basis of these average characteristics relies on repeatedly aligning our positions with them week after week, year after year. But we have literally no faith at all that a given Market Climate will resolve into specific short-term market performance.
So the change in our investment positions is based on evidence that the market is now living in a different probability distribution. This change is not associated with a forecast, beyond a small, unreliable and statistically insignificant expectation about what the market might do over the coming week, on average.
On the questions that needlessly fill investors minds, such as "Is this a bull market or a bear market," "Where is the market headed," "Where will the market be six months from now," "How long will this rally last," and "How close is the market to a top?": I honestly have no idea. I have no illusion that we can predict bull markets or bear markets. These things don't even exist in observable reality, only in hindsight, so what is the sense of using these concepts as the basis for investment decisions?
What I believe we can do fairly well is to identify observable conditions that are associated with differing average return/risk ratios for the market as a whole. These Climates may have some amount of overlap with what turn out in hindsight to be bull and bear markets, but we don't actually go out and try to identify bull or bear markets. Instead, we focus on reality as we find it.
We also don't evaluate the performance of our approach by whether we "call" specific tops, bottoms, rallies or declines. We evaluate our approach on the basis of return per unit of risk over an extended period of time. Specifically, our goal is to generate stronger long-term returns with smaller drawdown losses than experienced by the major indices over the full market cycle (bull market plus bear market). We hope that these criteria are also the ones that matter to our shareholders.
By the way, Value Line has a neat set of return/risk rankings for fund managers reported in the latest issue of Barron's (though the table has some typographical errors, and our ranking was computed without the benefit of our 3-year return figure - it's always something...). In any event, return per unit of risk is the correct measure by which to evaluate our approach, and we're pleased to be ranked on that basis."
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