Hussman: recession imminent

This is from his always worthwhile weekly Market Comment (this week he makes an airtight case against taking market risk at this time, with a recession all but guaranteed and no cushion of safety or reasonable expectation of a decent return in stocks or bonds).

I liked his comment about how although his fund has been very conservative and fully-hedged for most of the last several years, this is more a reflection of unfavorable market conditions than some sort of permabear tendency:

The overvaluation, misguided policy, and misallocation of capital that has produced more than a decade of dismal returns for the S&P 500 has also forced us to take a regularly hedged investment stance in response (though we know that the ensemble methods presently in use would have done things differently in several periods, particularly 2009 and early 2010). While our investment approach is by construction risk-managed, it is not by construction hard-defensive or fully-hedged. These are positions that have been thrust on us by conditions that have, predictably, led to a decade of stock market returns far below the historical norm. Though the present menu of prospective investment returns remains unappealing, those conditions can change quickly, particularly in a crisis-prone environment. This is important to mention here, because I strongly expect that we will begin seeing opportunities – probably not immediately but also not in the distant future – to significantly and perhaps sustainably reduce the extent of our hedging.

We emphatically don’t need to wait for the world to solve its problems before being willing to accept risk. What we do need is for those risks to be more appropriately priced in view of those problems. We’re not there by any means, but a significant change in the market’s return/risk profile could come quickly. To quote MIT economist Rudiger Dornbusch (who was a professor to the new head of the ECB, Mario Draghi), “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.”

See this part on how his never-failing set of recession indicators is again flashing red:

Reduce Risk

Here in the U.S., our broadest models (both ensembles and probit models) continue to imply a probability of oncoming recession near 100%. It’s important to recognize, though, that there is such a uniformity of recession warnings here (in ECRI head Lakshman Achuthan’s words, a “contagion”) that even an unsophisticated, unweighted average of evidence indicates a very high likelihood of recession. The following chart presents an unweighted average of 20 binary (1/0) recession flags we follow (e.g. credit spreads widening versus 6 months earlier, S&P 500 lower than 6 months earlier, PMI below 54, ECRI weekly leading index below -5, consumer confidence more than 20 points below its 12-month average, etc, etc). The black brackets represent official recessions. The simple fact is that we’ve never seen a plurality (>50%) of these measures unfavorable except during or immediately prior to U.S. recessions. Maybe this time is different? We hope so, but we certainly wouldn’t invest on that hope.


Hussman: Market risk is extreme

John Hussman is the rare mutual fund manager who uses technicals and hedging to minimize risk and maximize returns during a full bull-bear cycle. He hedged up in 2000 and 2007 to preserve his fund’s equity during the ensuing bear markets, and is again tightly-hedged in preparation for another downturn.

His weekly market comment is a must-read (if you just read this and Mish’s blog regularly, you’re all set). He uses a set of indicators to identify periods during which risk is elevated based on historical statistical analysis. They are: 1) stock market investor sentiment, 2) Case-Shiller PE ratio, 3) Treasury yield trends, and 4) price action (to indicate whether stocks are overbought or oversold using moving averages).

He concludes each market comment (in which he puts on his academic cap to discuss market statistics, Fed policy, etc in geeky detail), with a quick summary of where his funds are positioned according to the prevailing risk profile. When he starts his conclusion like this, you better not be long stocks:

Market Climate

As of last week, the Market Climate for equities was characterized by an unusually extreme profile of overvalued, overbought, overbullish, rising-yield conditions. Both Strategic Growth and Strategic International Equity remain tightly hedged here.

Here is a chart showing where these market conditions have existed in the past:

Gold:Silver ratio approaches support

The relative values of gold and silver are a measure of risk aversion, akin to the VIX. Silver is largely an industrial metal and reflects appetite for commodities in general, whereas gold is owned as hard cash for safety.

Witness the premium silver fetched in the commodities mania of 2007 to July 2008, and the soaring value of gold in the panic last fall. Like the VIX, it registered a peak in October and November and did not confirm the equity lows in March. There is also a correlation in recent months between Gold:Silver and the US dollar index (only 3% bulls there yesterday, by the way).

We’re now a few points above a level where two major trend lines intersect, though the RSI and MACD are already in oversold territory. A quick, terminal spike in silver would complete the pattern nicely:

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Readers know that I am a stomping dollar bull and precious metals bear at the moment. Gold bugs, take a chill pill — I’m all for a gold standard, and yes, gold will continue to outperform most other assets in this depression, but that doesn’t mean the metals aren’t overbought like everything else in this reflation/recovery mania. Possible spike tops notwithstanding, I expect both silver and gold to fall from here, and for silver to fall harder. I expect $14 within 6 weeks, followed by $12 early next year, and possibly even $8 in a year or two.

ProShares announcement: it was the ban.

ProShares Announcement
Friday September 19, 11:25 am ET

BETHESDA, Md.–(BUSINESS WIRE)–Due to the emergency action announced by the Securities and Exchange Commission on September 18, 2008, temporarily prohibiting short sales of shares of certain financial companies, Short Financials ProShares (SEF) and UltraShort Financials ProShares (SKF) are not expected to accept orders from Authorized Participants to create shares until further notice. Unless notified otherwise, shares will be available for redemption by Authorized Participants as normal.┬áThe shares of these ProShares are expected to trade in the financial markets today, but may trade at prices that are not in line with their intraday indicative values.

No more SKF for me, ever. I’m on an accelerated schedule to get out of the rest of my short ETFs. Too many wild cards, not enough disclosure.

Long-term puts only from now on. I had hoped to hold onto the ETFs until we started to really plunge, because I had figured market functions would hold up that long, but we are apparently on an express train to Animal Farm.

I wonder how many others feel the same? I bet this week’s shenanigans are going to put a lot of people off the markets entirely. All they have done is burn a few shorts and set the markets up for a rapid retracement of the last 900 Dow points, plus give or take a couple thousand to the downside.

Markets don’t drop because of shorts (though shorts can drive them up fast). Markets drop with the scales off of longs’ eyes.