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:

Max caution alert: exit or hedge all market risk

This is one of those times where markets are stretched to the limit and any further upside will be minimal in relation to the extreme risk entailed. Sentiment has been dollar-bearish and risk-bullish for so long that a violent reversal is all but guaranteed. This is not to say that the absolute top is in, but that at the very least, another episode like last April-June is coming up.

Watch for a sharp sell-off in stocks, commodities and the EUR-CAD-AUD complex. Even gold and silver are vulnerable, especially silver. We could be near a secular top in silver, where the recent superspike has all but gauranteed an unhappy ending to what has been a fantastic technical and fundamental play for the last decade. Gold is much more reasonably valued and should continue to outperform risk assets because the monetary authorities are so reckless, but there is just too much froth in silver to hope for even that.

The rally since early 2009 has been not just another dead cat bounce in the bear market from 2007 (like I thought it would be), but another full-blown reflation and risk binge like the 2003-2007 cyclical bull. The secular bear since 2000 is still here, and valuations and technicals suggest that another cyclical bear phase is imminent. There is no telling how long it will take or how it will play out, but the only prudent move at times like this is to take all market risk off the table. Bears still standing should think about going fully short. Anyone holding stocks should sell or get fully hedged. History shows that the expected 10-year return on stocks from conditions like this is under 3.5%, and such a positive figure is often only acheived after a major drawdown and rebound. See John Hussman’s excellent research on the topic of expected returns from various valuation levels:

Want to know what a secular bear looks like? Check out 1966-1982: a series of crashes and rallies that resulted in a 75% inflation-adjusted loss. In the absense of 70s-style inflation, this time the nominal loss should be closer to the real loss. Think Japan 1989-who knows?

The headlines this time around should have less to do with US housing, though that bear is still raging. We’re likely to hear much more about European sovereign debt, where haircuts and defaults need to happen, and Canadian, Australian and Chinese real estate. When the China construction bubble pops it will remove a major fundamental pillar from the commodities market.

There is no safe haven but cash, and cash is all the better since everyone has feared it for so long. If I had to build a bulletproof portfolio that I was not allowed to touch for five years, it would be something like this: 20% gold bullion, 25% US T-bills, 25% US 10-year notes, 25% Swiss Francs (as much as I hate to buy francs at $1.13) and 5% deep out-of-the-money 2013 SPX puts (automatic cash settlement).

There will be a great value opportunity in stocks before long (the tell will be dividend yields over 5% on blue chips). It’s just a matter of having the cash when it comes, so that you aren’t like the guy who said in 1932 that he’d be buying if he hadn’t lost everything in the crash.


PS – For those of you who think QE3,4,5,6 will save the markets, I’ll counter that it doesn’t matter, not on any time frame that counts. Risk appetite and private credit are what matter the most, and the Fed can’t print that. At 3AM, spiking the punchbowl doesn’t work anymore.

Or I can put it this way: the Fed has increased the monetary base from 850 billion to 2500 billion since 2007. Have your bank balance, salary and monthly bills increased 200%? If not, why should stock and commodity prices? Not even Lloyd Blankfein is 200% richer than four years ago.

Still 2007

Yahoo! Finance

I can’t draw on this chart, but you can clearly see the similarities in price, RSI and MACD between the last 6 months and the period leading up to final top of the even bigger bear market rally of 2003-2007. Will we levitate up here for a year like we did back then? I doubt it, since this is a smaller degree wave and the time scale is more compressed. It appears to be running out of steam after 12 months, not 4 years.

Since summer, the bears have been demoralized by time, not price — we’re only 1000 pts higher than last August. The bullish complacency and dejected state of the bear camp is what you need for a final top.

RSI and put:call signals like we have right now are what you need for a smaller-degree top. One of these smaller degree tops will turn out to be the big top. This is not the time to give up on shorting.

The tables are turning, and panic is on the way back.

I was extremely, almost uncomfortably short for the last couple of weeks, and with the Dow down 175 a few minutes ago, I covered my stock futures shorts and bought a few contracts to hedge up my long-term puts. It’s looking very good for the shorts — dollar up across the board, bond spreads wider, and stocks and commodities down together. Classic deflation trade.

Here’s the Dow. You can see that RSI says we’re already into oversold territory on the daily bar, which indicates the power of this move. There could be a bounce here, but I think stocks are where gold was after it fell hard from $1228 last month: they can rally, but the high is in. Now the bulls will be the ones fighting the tape.



Of course, the rally taught us bears to go easy and hedge up after little sell-offs like this, but that is going to be a frustrating stragegy if we’ve turned. As with the euro since the dollar index put in its low, surprises will be to the downside. I suspect not even this initial move down is over yet, maybe just the most violent part.

Take a look at the VIX. It has just blasted off – jumping over 50% in a week, most of it in just two days! This is giving us a very, very strong signal that panic is coming back, and in fact, was never very far off:

Toppy action today: bulls ready to stampede?

Today’s action reminded me of the trading on Sept 23, with a ramp up followed by a swan dive in the late afternoon. Traders will remember the 23rd as the Fed Wednesday that marked the top prior to the 5% sell-off into the first week of October. Here’s a 1-week view of the Russell 2000 futures:

Source: Interactive Brokers, LLC

We’ve now had 6-7 days of mostly sideways action on very high DSI and very low Put:Call readings, indicating persistent bullishness and complacency in the face of stagnating prices.

The market the last several days has been lead by the big tech names, the same stocks that charged ahead just as the market topped in October 2007.

Interestingly, gold has not sold off hard with stocks. I’ve just gone long a touch of gold and silver futures as a hedge to my stock futures shorts, since sentiment there is not extreme at present and the metals usually terminate in spikes, not rolling tops like they have formed recently. I remain bearish gold and silver on a multi-month time frame.

Scaredy bears


Well, we’ve hit the first common Fibonacci retracement level (38.1%). We’ve now rallied 350 S&P points after a 904 point fall (1570 to 666). This is the best shorting opportunity since 12 months ago, IMO.

Source: Interactive Brokers

Nasdaq is nicely lagging, and the dollar is looking good. China could have topped already. The chatter on the boards is of scared bears and confident momentum chasers.

Next week could be nasty, maybe a drop to 950 before a rally to test 1000 again soon thereafter. Or maybe we slowly roll over and don’t break 950 til almost Labor Day (first week of Sept — when summer vacation ends in the US).

If this really is wave 3 down, it should be another 5 wave move, like wave 1. During the first wave, and even the second, most won’t believe the top is really in. Wave 1 could start from right here, since the momentum guys would be buying in on the decline and there would be few shorts to drive a squeeze to new highs. It would be seen as a “healthy correction.”

This is it: we have a major top this week.

Frequent readers know that I watch sentiment and put a lot of stock in Investor’s Intelligence and Daily Sentiment Index surveys, and that when extremes in sentiment match with extremes in price, it is as good a trade as the market ever provides. Well, we have 3% dollar bulls today. The dollar is going to blast off from here and kill the stock and commodity rally and blow credit spreads wide open. It also appears that emerging market (including Chinese) stocks have already started stair-stepping lower.

The dollar vs. the euro, pound, Aussie and Loonie — a loaded springboard:

Chart from Yahoo!

I see three clear waves up from March in stocks and commodities (three is what you need for a complete countertrend move), with big B-wave moves down in the dollar and bonds, which now have the potential to blow right through their highs from last winter’s deflation trade. In stocks and commodities, the sell-off into early July was the b-wave (of 2 of C), where the hobby bears jumped in, and the rally since has crushed all but the most disciplined, patient and deep-pocketed shorts. On the cusp of the big 3rd wave down, this is definitely not the time to lose religion.

Commodities’ last gasp (indexes here):

Credit: Bloomberg.

Watch for VIX liftoff as well to add extra oomph to put portfolios.


I’m sitting on puts on oil, silver, stocks, the euro and pound and calls on Treasuries. There are no guarantees in the market, so anything could happen, but I’ve never felt better being short (my puts are comfortably long-dated, of course). A sharp pullback might set us up for new highs, though I doubt it. I’m expecting a typical rollover at first, with increasingly jagged price movements (remember when almost every day saw 3% swings?), but not necessarily full-on crash conditions for several weeks to months.

Don’t trade like me (I’m a wild man), and good luck out there.


Here’s the much mentioned analogue to the ’29-’30 post-crash rally (image from D. Rosenberg at Gluskin Sheff — sign up for his free letters here):