Market Climate
As of last week, the Market Climate for stocks was characterized by unfavorable valuations, and unfavorable market action, with a leadership reversal coming just off of an overvalued, overbought, overbullish syndrome, and accompanied with heavy downside breadth. This type of event has produced fairly benign outcomes about 20% of the time. The remaining instances have been hostile, on average, and in the majority of cases were observed at the beginning of steep market declines. It is difficult to review that record with equanimity about what may occur in the present instance, but again, about 20% of those outcomes were fairly benign. I think it is sufficient to strongly urge investors to review their risk exposures here (and to be comfortable that a significant market loss would not derail their financial security or short-horizon spending needs). Again, I do not encourage investors to deviate from careful and disciplined investment strategies, or to establish "bearish" positions. For our part, the Strategic Growth Fund is fully hedged. The primary source of day-to-day fluctuations in the Fund here is the difference in performance between the stocks held by the Fund and the indices (S&P 500, Russell 2000, Nasdaq 100) that we use to hedge.
In bonds, the Market Climate last week was characterized by moderately unfavorable yield levels and favorable yield pressures. Credit spreads continued to widen last week, so despite periodic selloffs in Treasuries on various "relief" news (such as the nearly obligatory assurance from China that it had no plans to dispense of euro-denominated debt), I continue to expect Treasury securities to act as preferred safe-havens in response to fresh credit strains. Though these strains are likely to suppress inflation pressures over the shorter run, the reckless fiscal and monetary attempt to make bad debt whole, rather than encouraging its restructuring, has very unfavorable long-term implications for the purchasing power of the U.S. dollar.
I still believe that inflation pressure is likely to emerge in the second half of this decade, not over the near term. Still, precious metals shares tend to perform well in the face of downward real interest rate pressure and a high ratio of physical gold prices to the underlying stock prices. In view of that combination, the Strategic Total Return Fund continues to accumulate precious metals shares on short term weakness, and we are comfortable with gradually building a moderate (5-10%) exposure.
We can't rule out a spell of downward commodity price pressure if concerns emerge about potential economic weakness, so we're not seeking anything close to an aggressive exposure here, but our current position will give us adequate participation even if economic weakness doesn't offer us another bite at the apple, so to speak.
* Geek's Note: the actual calculation is P(S'|S) = P(S'|F)P(F|S)+P(S'|~F)P(~F|S)
Copyright (c) 2010 John Hussman, Hussman Funds
