Hussman Weekly Market Comment: Reduce Risk
Reduce Risk
Here in the U.S., our broadest models (both ensembles and probit models) continue to imply a probability of oncoming recession near 100%. It's important to recognize, though, that there is such a uniformity of recession warnings here (in ECRI head Lakshman Achuthan's words, a "contagion") that even an unsophisticated, unweighted average of evidence indicates a very high likelihood of recession. The following chart presents an unweighted average of 20 binary (1/0) recession flags we follow (e.g. credit spreads widening versus 6 months earlier, S&P 500 lower than 6 months earlier, PMI below 54, ECRI weekly leading index below -5, consumer confidence more than 20 points below its 12-month average, etc, etc). The black brackets represent official recessions. The simple fact is that we've never seen a plurality (>50%) of these measures unfavorable except during or immediately prior to U.S. recessions. Maybe this time is different? We hope so, but we certainly wouldn't invest on that hope.
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Meanwhile, nearly every traditional asset class is priced to achieve miserably low long-term returns. While Wall Street remains effusive about stocks being cheap on a "forward operating earnings" basis, that conclusion rests on the assumption that profit margins will sustain record highs more than 50% above their historical norms into the indefinite future. That assumption is terribly at odds with historical evidence (as it was in 2007 when Wall Street was gurgling exactly the same thing). Given that stocks are a claim on a very long-duration stream of deliverable cash flows, our money is clearly on more thoughtful and historically reliable valuation methods.
Consider the menu of traditional investment opportunities here. The yield on 10-year Treasury notes is just 2%, 30-year yields are at 3%, the Dow Jones Corporate Bond Index is yielding just 3.5%, our estimate for 10-year nominal S&P 500 total returns is now at just 4.5%, and our 10-year total return estimate for higher-yielding utilities is still at just 5.5% annually (a figure that, while higher than our estimate for the S&P 500, is still among the lowest 15% of historical observations). So Ben Bernanke has done his job well, given that he believes his job is to drive investors into higher-risk assets by starving them of yield on safer investments. The end result is that investors face a perfect storm - risky assets priced to achieve dismal long-term returns (except in comparison to equally dismal alternatives), coupled with the risk of an oncoming global recession.
In our view, investors should presently hold risky assets only in the amount they would be willing to hold through the duration of significant downturn, without abandoning them in the interim. For buy-and-hold investors, that amount may be exactly the same as they are holding at present, but the choice should be a conscious and deliberate one.
- Links
Q&A with Guy Spier about his book, The Education of a Value Investor (LINK) Buffett’s Private Analysis of Geico in 1976: ‘Extraordinary’ But ‘Mismanaged’ [H/T Lincoln] (LINK) Aswath Damodaran on corporate break-ups, using EBay and PayPal...
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