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Hussman is not that bad. BEWARE.

I read John Hussman every weak. I don’t use it for my trading but for some good analytics. Hussman’s weakly commentaries provide some very good historical perspective and some great economic theory. It provides a technical and objective view. His fund has been a dog recently and he has been criticized of being too defensive in the world of infinite QE. Something caught my attention in his recent weakly. You can find it here. He wrote “As of Friday, our estimates of prospective return/risk for the S&P 500 have dropped to the single lowest point we’ve observed in a century of data.” A century is a long time and his model is pointing to the worst risk/return odds in that period. I though I should look more closely into his model and track record. First how has his model/fund performed? Below is a chart of his flagship fund “Hussman Strategic Growth Fund” since inception. As you can see it has outperformed S&P500 by a wide margin. That puts Hussman in the top single digit percentile of the funds industry. What’s amazing is its performance during 2008-09 period compared to S&P500 drawdown. Their peak drawdown was around 20% compare to fall of 55%+ of the S&P500.

And on July 16 2007, when S&P was over 1550 and everything looked rosy, Hussman published a very bearish commentary. That pretty much proved the top for the S&P500. This is significant as he was extremely out of consensus and was proved right. You can read that post here.

These points demand taking a closer look when he says his model points to the worst risk/reward in a century. He suggests that his model forecasts less that 4% p.a. nominal return for S&P 500 over the next 10 years. The bottom chart plots his models return forecast with subsequent actual returns over a long period. The model looks decent in predicting future returns quiet broadly. There are some periods of divergence. The current return projection of less than 4% is where his model was in 2007 before the market crashed. This level is pretty much the lowest levels of return projection by his model except for the Tech bubble of 2000. Interesting to note that during the tech bubble, the model predicted negative return over the next ten years in 1998 which materialized as well. The point to note here is his returns model is predicting the lowest return for S&P 500 ex Tech bubble. Unless the expectation here is that there is going to be an irrational bubble beyond logic, his model is pointing to a market top.

In his latest note, he points to 4 conditions which are seen now and how market traded in past instance of the same conditions. The conditions below. 1) The Shiller P/E exceeded 18 2) The S&P 500 was above its upper Bollinger bands on daily, weekly and monthly resolutions 3) The percentage of advisory bulls exceeded 45%, with bears less than 27% (sentiment data prior to 1960 is imputed based on the strong post-war relationship between sentiment and measures of price momentum) 4) The 10-year Treasury yield exceeded its average over the prior 6-month period In chart below shows the S&P 500 since 1928, with blue bars identifying points where all 4 above conditions are true. In all but one instance, S&P 500 sold off shortly. The

exception was 1997 which again was the Tech bubble. This also points to situation that market is due for sell off unless an irrational bubble is building up.

Many would argue that the low return expectations are justified because of the low interest rate environment we are in for the foreseeable future. At 10Y UST below 2%, a 4% p.a. return in S&P500 for next 10 years is not bad right? But Hussman argues in one of his commentaries “the correlation between 10-year S&P 500 returns and 10-year Treasury bond yields (which reflect both expected and actual 10year returns, provided no default occurs) is just 0.1. There is virtually no relationship at all, with the exception of the early-1980’s, when the prospective and actual returns were quite high for both as a result of inflation shocks.” Link: This is seen from the second chart which I have posted. So it’s not true that low interest rates mean lower return expectations. One has to take note here that debt and equity are different asset classes with different risks, characteristics and volatilities. Bottom line, Hussman has underperformed recently buy his models have a good track record over long periods. They are flashing the worst risk/reward in a century for S&P500 right now. His models and pointers have been wrong in the past during the Tech bubble. Unless you think we are going into some irrational bubble in equities, it might be a good time to sell equities here and sit on cash for better times. BEWARE.