Monday, April 22, 2013

My answer to John Hussman

I have the greatest of respect for John Hussman. His weekly commentary has always a must-read for me. So it was with much interest that I watched the video of his speech from the Wine Country Conference (via Mebane Faber).

I came away thinking that while I agree with Hussman's analysis on many fronts, we came away with some very different conclusions - a result that I will explain.

Where I agree with Hussman
If you watch the video, you will see that at the beginning, John Hussman states that he believes that much scarce savings has been squandered. Instead of directing savings towards productive innovation, e.g. robotics, etc., it has gone into financial manipulation (my words, not his) in trying to save the current system.

I completely agree.

Hussman went on to say that QE doesn't work to stimulate long-term sustainable growth. It only serves to drive down interest rates and lower the risk premium, which results in a speculative reach for yield.

I agree.

He went on to outline his 10-year return expectations for stocks. Based on various approaches, he gets an expected return of roughly 3.5%. Indeed, Mark Hulbert highlighted a similar conclusion based on the 3-5 year appreciation potential of stocks from the Value Line Investment Survey.

Hussman 10-year equity return expectations

Unfortunately for the investor, there are no good alternatives in the current QE environment. Expected returns are low for all asset classes.

Hussman called the current environment "An Unstable Equilibrium". In other words, the markets are an accident waiting to happen.

I agree with his analysis. While stocks returns can be relatively benign in the short to medium term, there are at least two major macro tail risks that we have to be concerned about: France (see Short France?) and China (see The canaries in the Chinese coalmine and An update on my Chinese canaries). In other words, the markets can behave for a while and then the roof could suddenly cave in. That's why we have an unstable equilibrium.

Same analysis, different conclusions
What can an investor do under these circumstances? That's where I differ from John Hussman. It appears that Hussman manages his fund primarily based on his 10-year rate of return outlook expectation. If return expectations for all asset classes are low, it makes sense to focus on capital preservation and to go long opportunistically. It's a long-term investment viewpoint, much like the sort adopted by pension fund committees and fiduciaries that I used to speak to in my previous life as an institutional money manager. I understand that point of view completely.

Today, I, along with people like Mebane Faber, believe that we have models that can trade the swings in this market - and there are plenty of swings. In effect, Hussman is saying that we are in a modern day depression - sort of a Japanese Lost Decades-like environment. The economies of the developed world is likely to go through cycles of upswings caused by fiscal and monetary stimulus and declines as the stimulus is withdrawn, largely scarce savings is not being directed at productive investments.

My principal approach is to use my Inflation-Deflation Trend Allocation Model, supplemented by price momentum at the appropriate times. While Hussman's time horizon is measured in years, my time horizon is measured in weeks and months. That's why, despite the poor long-term return expectations, I can be relatively sanguine on the outlook for the stock market. (More on that in a future post.)

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.


Anonymous said...

Cam, as it pertains to your Inflation-Deflation model of asset allocation here is a similar tool which I'd be curious to hear your comments on. Am I wrong in presuming that value investors are smarter than the market-at-large? Here I use value-based ETF vs Wilshire to compare inflation/deflation trade (via WLSH vs TLT)

Cam Hui, CFA said...

Value investors have indeed been outperforming, but Value and Growth go through cycles of out and under-performance.

See my recent post

SWW said...

There is only one kind of investing, laying out today's dollar to gain more purchasing power of the future after discounting for inflation. And there is no such thing as growth vs value investing, as Buffett & Munger trying to tell us last 30 years, "value and growth are join at the hip." The moment you try to differentiate them you are probably not in the Investors club.

By the way, Hussman funds is one of the worst return fund I've ever seen. Using 1, 3, 5, 10 years to look at his performance, there is only one explanation when market rally from 2009 March to 2013 Dec and you able to lost 20%+

- Incompetent.

I'll advise you not to listen or read his "whatever".