This week we visit some very thoughtful analysis by an old friend of Outside the Box, Dr. John Hussman of the Hussman Funds (http://www.hussmanfunds.com/index.html). Is the new PPIP program and related activities likely to help or hurt the situation? Will this help keep banks for bankruptcy or will it push the FDIC into insolvency requiring massive tax payer cash. This week's Outside the Box is brief, but poignant.
What does a bubble look like and how do they end? In this week's Outside the Box, James Montier of Societe Generale in London looks at not only the psychological analysis, but also at the propensity for commentators to continually proclaim the end of the problem and a resumption of business as usual. He includes a fascinating piece from Marc Faber documenting the various quotes about how well the economy was doing from 1928-32. This makes for fun, if a little sobering, reading.
To quote from his summary:
"We have seen the heads of virtually all financial institutions stand up over the last few months and claim the worst is behind us. Why would anyone listen to these people? They didn't see the disaster coming, and yet somehow they are qualified to tell us it is all alright! Perhaps I am just unduly sceptical, but this reeks of a conspiracy of optimism. The recession has barely started, let alone reached its nadir. The market moves of late have all the hallmarks of a classic sucker's rally. This isn't discounting the recovery, this is denial! Far from being behind us, the worst may well still be ahead!"
I think you will find this letter very interesting.
Is this the week the Dow will break 12,000? Will we once again see $50 barrel oil? Are we in a Goldilocks economy? These are all questions that investors are confronted with by the financial press. In today's "Outside the Box," we will focus our attention on a well-thought piece by John Hussman, Ph.D. John is the President of Hussman Investment Trust where he manages the Hussman Strategic Total Return Fund - HSTRX and the Hussman Strategic Growth Fund - HSGFX.
In his Weekly Market Comment, John addresses the continued bull market run and compares it in duration to that of previous market cycles. We have currently gone 906 days without a 10% correction. John goes on to further explain the meaning behind this trend by discussing the level of P/E ratios and the climate for bond yields. One particular interesting part of his analysis is when he shows returns over a "full market cycle.
So, how does a money manager with these views cope in today's market? I keep John's comments about what he is doing in his fund so you can see what this highly regarded professional hedges his bets. I think you will find what he is doing to be instructive.
While most investors continue to watch their streaming ticker for new record highs, we are patiently waiting for the raw data to form our investment decisions. I believe you will find this commentary to be both valuable and "outside the box."
"The current state of volatility is an indicator of a potentially sharp stock market decline based upon (i) the currently low level of volatility, (ii) the tendency for upward spikes to follow extreme low volatility, (iii) the relationship of market direction to volatility trends, and (iv) the propensity for downside volatility during secular bear markets. Volatility could decline further and could remain low for some time longer; however, based upon history, it has not stayed low without subsequently spiking and, as it goes lower, the likelihood of a spike increases significantly.
When volatility does start to rise and the stock market likely declines, the bulls will call it a "pullback" or a "correction" in advance of the next major upward move in the market. Because we are currently in a secular bear market (at the least, a bear-in-hibernation), the market can be expected to act as it has during the past secular bear markets. Keep in mind: over the course of secular cycles, the market is driven by recognized principles of economics and finance. The current market conditions are not positioned to provide another secular bull market at this time--it is not a sleeping bull. The current conditions reflect a secular bear or a bear-in-hibernation because the price/earnings ratio ("P/E") is above its historical average. Without a rising P/E, future returns will be below average and investors are likely to experience an extended, choppy, and often volatile period.
There are strategies to employ to capitalize on volatility and to protect downside risk. Recognition is empowering. It is incumbent upon investors to understand the environment and to seek profit-oriented investments rather than hope that the market will again provide the passive rewards that occurred during the secular bull market of the 1980s and 1990s."
This week we will turn our attention to a topic of intrigue, volatility, one of which I think is becoming increasingly important. Ed Easterling, a good friend and fellow hedge fund colleague of mine, has performed an in-depth study on volatility trends and their effects on the capital markets. I have been harping on a similar theme in my e-letter, Thoughts from the Frontline, which I recommend you read in conjunction with this if you have not already.
Ed Easterling is the author of Unexpected Returns: Understanding Secular Stock Market Cycles, President of an investment management and research firm, and a member of the adjunct faculty at SMU's Cox School of Business where he teaches the course on alternative investments and hedge funds for MBA students. Mr. Easterling publishes provocative research on the financial markets at www.CrestmontResearch.com.
"The Calm Before the Storm" uncovers the current and historical levels of volatility in the marketplace and explores their impact on both secular bull and bear market cycles. Moreover, Ed goes on to discuss what those trends mean for investors' expectations and returns in the not too distant future. I trust that you will indeed benefit from Mr. Easterling's fundamental research and his "outside of the box" insights.
This week's letter is from my good friend Ed Easterling of Crestmont Research in Dallas. Ed helped co-author a couple of Chapters in my book "Bull's Eye Investing" and that inspired him to write his own book. Ed's recently published, a must read book in my opinion, is called "Unexpected Returns: Understanding Secular Stock Market Cycles."
This article uses some of the insightful research in the book to examine current market conditions and why Ed thinks the "Four Categories" are pointing to a bear market decline in the near future.
Successful investing is all about recognizing and managing risk and not looking for the next home run. It is a lesson we all need to understand. I hope you enjoy this week's edition of Outside the Box.