To give you some idea of the distinction, the following chart shows S&P 500 earnings (TTM) versus NIPA profits, scaled so that each series begins at the same value in 1963. Notice that in 1963, both measures would have (by construction) given you the same P/E multiple. But presently, the NIPA line is over 60% higher than the net earnings line (the same is true for 10-year averages), so any P/E based on NIPA profits is substantially and misleadingly low. Again, earnings reports for the S&P 500 companies are directly available. The NIPA figure does not even cover the same universe of companies as the S&P 500, and excludes a whole host of relevant expenses. In effect, by using NIPA profits, you gradually skew the profile of valuations over a period of decades so that what would normally represent clear overvaluation today is transformed into something that looks soothingly appropriate. It is not.
Market Climate
As of last week, the Market Climate for stocks remained characterized by unfavorable valuations and unfavorable market action. The Strategic Growth Fund remains fully hedged here - nearly fully invested in individual stocks, with an offsetting short sale of approximately equal dollar value in major indices such as the S&P 500, Russell 2000 and Nasdaq 100, to mute the impact of market fluctuations from the portfolio. As usual, when the Fund is hedged, the primary source of day-to-day fluctuations is the difference in performance between the stocks we hold long and the indices we use to hedge.
In bonds, the Market Climate last week remained characterized by moderately unfavorable yield levels and still favorable yield pressures. We clipped a bit more of our precious metals position on strength last week, as deflationary concerns are likely to become a primary focus of investors well before inflationary concerns correctly become relevant several years out. Between its inflexibility to political and economic freedom and a banking system that is both underdeveloped and at increasing risk of overinvestment-induced credit strains, my impression is that China is much more likely to stumble than investors may appreciate. To a large extent, the strength in commodities has been tied to very rapid growth assumptions across developing economies. We've generally done best by accumulating commodity exposure when investors are abandoning it. That's not to say I expect a major downturn, but as I've frequently noted, the long-term thesis for gold may be forced to endure shorter term discomfort.
Finally, I'm pleased to note that on Thursday, the expense ratio for the Hussman Strategic Growth Fund (HSGFX) was again lowered, this time from 1.04% to 1.02%, reflecting a reduction in the investment advisory fee (approved at the June meeting of the Hussman Funds Board of Trustees), and general growth in Fund assets. Fund expense ratios are affected by a number of factors including fee breakpoints and the level of Fund assets, and may increase or decrease over time.
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