A Brief Primer on the European Crisis
Our estimate of the prospective return/risk tradeoff in the stock market remains in the most negative 0.5% of historical instances. That said - and this is important - if market internals improve meaningfully over the next few weeks (measured across individual stocks, industries, sectors and security types), our estimate of the market's prospective return/risk profile would improve, despite what we view as rich valuations and a new recession. Very roughly speaking, this would require a solid rebound in market internals over a period of 2 or 3 weeks. That sort of outcome might accompany a Fed easing or other event, but our focus is on the measurable condition of market internals, not on Fed policy or other news per se. A positive shift in our measures of market action would likely be enough to ease back from our tightly hedged investment stance to a slightly constructive position. For now, we don't have the evidence to take anything but a very defensive stance, but we'll take changes in the evidence as they arrive.
It's fair to say that we don't foresee any development that would encourage us to remove a major portion of our hedges at present, and my personal expectation is that conditions are likely to deteriorate sharply rather than improve, but as always, I want shareholders to know where my attention is focused. Our measures of market action - and any meaningful improvement over the next few weeks - will be important in determining the whether we maintain a tightly defensive stance or shift to a slightly constructive one.
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