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Hussman Weekly: Erasers

August 06, 2012

I’ve never been very popular in late-stage bull markets. Defending against major losses and achieving our investment objectives over the complete bull-bear market cycle (bull-peak to bull-peak, or bear-trough to bear-trough) requires us to maintain an investment exposure that is essentially proportional to the expected return/risk ratio that is associated with each given set of market conditions. When prevailing market conditions are associated with a sharply negative expected return/risk ratio, as they are at present, and either trend-following measures are negative or several hostile indicator syndromes are in place (what we call Aunt Minnies), we will typically be fully-hedged, and will raise the strike prices of our put options toward the level of the market, in order to defend against steep market losses and indiscriminate selling. At present, we expect an average 10-year total return on the S&P 500 of about 4.7% annually in nominal terms, on the basis of rich normalized valuations. Based on a much broader ensemble of evidence, and considering horizons between 2-weeks and 18-months, we estimate the prospective return/risk ratio of the S&P 500 to be in the most negative 0.6% of all historical observations.

Moderate losses may be a necessary feature of risk-taking, but deep losses are erasers. A typical bear market erases over half of the preceding bull market advance. It is easy to forget – particularly during late-stage bull markets - how strongly this impacts full-cycle returns. The most obvious example, of course, is the 2008-2009 decline, which erased not only the entire total return of the S&P 500 since its 2002 low, but also erased the entire total return of the S&P 500 in excess of Treasury bill yields (its “excess return”) going all the way back to June 1995 - making all of the benefit from risk-taking during the late-1990’s completely for naught. Similarly, the 2000-2002 bear market wiped out the excess return that investors had enjoyed in the S&P 500 all the way back to February 1996. The 1990 bear market wiped out the excess return of the S&P 500 all the way back to January 1987.

Recall that at the 1987 peak, the S&P 500 had quadrupled (including dividends) from the secular low of August 1982. The 1987 crash – which in terms of size was a fairly run-of-the-mill bear of -33.51% from peak to trough - was enough to wipe out nearly half of that preceding total return (do the math: [(4*(1-.3351)-1]/(4-1)-1 = -45%), and slashed the excess return that investors had enjoyed since 1982 by even more than half. This chronicle of unpleasant arithmetic can be extended indefinitely over market history. Regardless of whether stocks are in a secular bull market or a secular bear market, the mathematics of compounding are brutal where large losses are concerned.

It’s instructive that $1 invested in Strategic Growth Fund at its inception, near the beginning of the 2000-2002 bear market was worth 2.72 times the value of an equivalent investment in the S&P 500 by the end of that bear market. Likewise, $1 invested in the Fund at the beginning of the 2007-2009 bear market was worth 2.09 times the value of an equivalent investment in the S&P 500 by the end of that bear market (see The Funds page for complete performance information). Performance gaps that can arise in the overvalued but still-advancing part of the full market cycle can be dramatically recovered by defensive strategies in the declining part of the cycle, which is why we don’t pay excessive attention to short-term tracking differences when market conditions are hostile.

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Rating: 2.7/5 (9 votes)


Traderatwork - 5 years ago    Report SPAM
"It’s instructive that $1 invested in Strategic Growth Fund at its inception, near the beginning of the 2000-2002 bear market was worth 2.72 times the value of an equivalent investment in the S&P 500 by the end of that bear market"

Beware that he is comparing SP500 performance with his fund performance,

SP500 2002 Jan 2: 1130.20

SP500 2012 Jan 3: 1258.86

Total Return: 11.38% for 10 years

Annual Compound Rate: 1.08% (exclude dividend)

According to his fund: http://www.hussmanfunds.com/theFunds.html

Total Return: 26.77% for 10 years

Annual compound: 2.04%

Last 5 years this fund annual compound rate: - 3.12% (every year lost 3.12%) and that's mean: $1 in 2007 is now $0.85

Twaddle of this long article does not make it looks good. If I have this type of "performance" I'll start a new fund and have a clean slate rather than writing articles to tell potential customers otherwise.

Tkervin - 5 years ago    Report SPAM
My guess is that Hussman will have the last laugh over the "Buy, buy, buy" set.......the next few months will be constructive I think.
Mi - 5 years ago    Report SPAM
What is it with the Gurufocus love affair with John Hussman? I dont see anything remotely value-oriented in either his philosophy, strategy, or methodolgy. He is a market-timer and "Crystal-baller" plain and simple. If I remember correctly, Gurufocus "Sold" Bill Miller around the third quarter of 2008 and "bought" John Hussman around October of 2008. It was a classic case of selling low and buying high as the two charts attached amply illustrate. Miller, as horendous as his fund performance has been, has outperformed Hussman over the trailing 10 years, as well as, since October of 2008. I believe Miller stepped down from the day-to-day management of LMVFX in April of this year.

I've been an investment consultant for a long time. I've never seen an equity investment strategy exclusively designed to avoid risk outperform a strategy that takes market risks over extended periods of time. Risk DOES equal return in the equity markets. Investing in Hussman in the depths of a Bear Market was a classic case of performance chasing. An investor would have been far more profitable by doubling down on good or even average equity managers at the depths of the Bear. It is ever thus.


Sww - 5 years ago    Report SPAM
Found this today, let's compare FairHolme Fund by Bruce Berkowitz

Cumulative Returns

1-Year 25.47%

5-Year 60.80%

10-Year 196.02%

Since Inception 342.88%

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