Fund Notes and Commentary: Archived Comments
July 20, 2015
As of mid-July, equity valuations have advanced to nearly twice their historical norms on the basis of measures we find best correlated with actual subsequent S&P 500 total returns (such as the ratio of market capitalization to corporate gross value added). Following an extended period of extremely overvalued, overbought, overbullish conditions, market internals have also deteriorated, as measured by broad market behavior across individual stocks, industries, sectors and security types. The divergence between capitalization-weighted and equal-weighted market indices such as the S&P 500 and Nasdaq 100 was particularly extreme last week, reflecting a striking narrowing of market leadership to a handful of large-capitalization stocks. This “two-tiered” market behavior is a well-known feature of prior speculative peaks, and was also observed during the late-1960’s “-tronics” boom, the “Nifty Fifty” mania of the early 1970’s, and the technology bubble that ended in the 2000 market peak.
Despite market valuations that we view as unfavorable for the long-term return prospects of U.S. stocks, our immediate concerns about downside risk would be eased in the event that market internals were to improve on our measures. At present, we remain highly defensive.
Strategic Growth Fund remains fully invested in a broad portfolio of individual holdings, and is fully hedged using long-put / short-call index option combinations using the S&P 500, Russell 2000, and Nasdaq 100 indices. Current market conditions couple both unfavorable valuations and unfavorable market action on our measures. We classify these conditions among an extreme group of periods representing only 8% of history. In this environment, the Fund holds a “staggered strike” position that raises the strike price of the index put side of its hedge close to at-the-money levels. The broad market (measured, for example, by the NYSE Composite Index) is relatively unchanged over the past year, but the capitalization-weighted S&P 500 and Nasdaq 100 Indices have been stronger. The Fund has experienced a moderate loss because of a similar difference in performance between the stocks held by the Fund and the market indices it uses to hedge, with a smaller drag on performance due to time decay from the higher-strike index put options held by the Fund.
In the context of present market conditions, we continue to view a highly-defensive staggered-strike hedge as appropriate to these market extremes, and we expect the two-tiered market behavior to be transient, as it has in prior market cycles across history. We can’t rule out a more extended period of time-decay or two-tiered market behavior, but we believe that the adaptations that we introduced to our methods in mid-2014 (which generally restrict the use of staggered-strike positions to periods featuring unfavorable market internals) have substantially reduced the risk of extensive hedging costs. Again, an improvement in market internals would significantly ease our immediate concerns about downside risks for the general market.
Strategic Total Return Fund presently has a duration of less than 4 years in Treasury securities (meaning that a 100 basis point move in Treasury yields would be expected to impact the Fund by less than 4% on the basis of bond price fluctuations). Last week, the Fund increased its holdings of precious metals shares on profound weakness in gold stock prices. As of Friday’s close, the Fund held about 12% of assets in precious metals shares, which we view as a moderate but not highly aggressive stance. We presently don’t see the likelihood of major, secular trends in either bonds or precious metals shares. Rather, we expect that the best way to seek total returns in these asset classes in the next few years will be to accumulate precious metals shares and long-term bond exposure on material price weakness, and reduce that exposure on material strength.
From the standpoint of the equity markets, we view severe price weakness as the dominant prospect over the next couple of years. Over a longer time horizon such as a decade, our impression is that the best way to seek total returns will be to accumulate exposure to the stock market on material weakness and reduce it on material strength (as we observe presently). The apparent beauty of Federal Reserve policy that has driven risky assets to extreme valuations is that the rear-view mirror creates the impression that downside risk is minimal, returns are free or even assured, and that investors need to do nothing but passively hold risky assets without regard to valuation or market conditions. We believe that this view is profoundly incorrect. When valuations are elevated to extreme levels, the rear-view mirror appears as a glorious ascent exactly because the windshield looks out on a roller-coaster track.
Both Strategic International Fund and Strategic Dividend Value Fund are fully hedged at present. As in Strategic Growth Fund, the main challenge to hedged-equity strategies over the past year has been the dispersion between capitalization weighted indices and broadly diversified portfolios that don’t hug the index weightings. To some extent, value-oriented stocks have also been less favored in this narrowing market environment, with very large-capitalization social networking and technology stocks being the most popular vehicles for speculation. Again, we believe that this two-tiered market behavior is likely to be transient. Indeed, widening dispersion and deterioration in market internals, following an extended period of extreme overvalued, overbought, overbullish market conditions, has been one of the primary signals that willingness of investors to accept risk is becoming selective, and is no longer robust.As always, our investment outlook will change as market conditions change – primarily on the basis of valuations and market internals. As of mid-July, the Hussman Funds remain strongly defensive toward equities, and moderately constructive toward Treasury bonds and precious metals shares.
April 11, 2015
As of March 31, 2015, the Hussman Funds remained strongly defensive toward equities, slightly constructive toward Treasury bonds, and moderately constructive toward precious metals shares. The severity of recent overvalued, overbought, overbullish conditions, combined with widening credit spreads and divergent market internals, presently contributes to a significant risk of abrupt market losses. These conditions will not persist indefinitely, and we fully expect that more neutral or constructive conditions will emerge over time. As of March 31, 2015, Strategic Growth Fund maintained a staggered-strike hedge that placed the strike prices of the index put option side of its hedge close to market levels.
Strategic Dividend Value Fund and Strategic International Fund also remained fully hedged. Despite rich market valuations, an improvement in market internals and a narrowing of credit spreads would reduce the immediacy of our concerns, and could encourage a more constructive stance. We continue to view the U.S. dollar as broadly overvalued relative to the Japanese yen and the Euro, despite concerns about quantitative easing in those countries that has created pressure on those currencies in the shorter run. Given that Strategic International Fund, by intention, is not strongly hedged against foreign currencies, day-to-day fluctuations in the Fund are largely a reflection of strength or weakness in the value of major foreign currencies (and are largely inverse to strength or weakness in the exchange value of the U.S. dollar).
In response to fluctuations in bond yields, Strategic Total Return Fund has generally varied its bond market duration between 1.5 years and about 5 years during the past quarter (meaning that a 100 basis point change in Treasury yields would be expected to impact the Fund by about 1.5% to 5% on the basis of bond price fluctuations). As of March 31, Fund duration was near the low end of that range.
Strategic Total Return Fund also held a moderately constructive, though not aggressive, position in precious metals shares typically ranging between 10-15% of assets during the past quarter. Notably, the Philadelphia Gold Index (XAU) has declined by 70% since April 2011. While Strategic Total Return Fund has gained value during that time, and the Fund - including reinvested distributions - is within 5% of its all-time high, even a modest exposure to precious metals shares has been a headwind in the past few years, relative to strategies that wholly exclude such exposure. Given that precious metals shares often move opposite to the U.S. dollar, part of the weakness in gold has been related to the advance in the dollar versus foreign currencies. Over the longer term, the precious metals component of the Fund's strategy has contributed to Fund returns, and we continue to view this component as important for diversification and the maintenance of long-term purchasing power. A constructive, though not aggressive, exposure to precious metals shares remains appropriate in our view.
January 12, 2015
As of early January, the Hussman Funds remain strongly defensive toward equities, slightly constructive toward Treasury bonds, and moderately constructive toward precious metals shares. The severity of recent overvalued, overbought, overbullish conditions, combined with widening credit spreads and divergent market internals, presently contributes to a significant risk of abrupt market losses. These conditions will not persist indefinitely, and we fully expect that more neutral or constructive conditions will emerge over time. As of the week ending January 9, 2015, Strategic Growth Fund maintains a staggered-strike hedge that raises the strike prices of the index put option side of its hedge close to market levels.
Strategic Dividend Value Fund and Strategic International Fund also remain fully hedged. Despite rich market valuations, an improvement in market internals and a narrowing of credit spreads would reduce the immediacy of our concerns, and could encourage a more constructive stance. We continue to view the U.S. dollar as broadly overvalued relative to the Japanese yen and the Euro, despite concerns about quantitative easing in those countries that has created pressure on those currencies in the shorter run. Given that Strategic International Fund, by intention, is not presently short foreign currencies, day-to-day fluctuations in the Fund are largely a reflection of strength or weakness in the value of major foreign currencies (and are largely inverse to strength or weakness in the exchange value of the U.S. dollar).
Importantly, the broad market as measured for example by the NYSE Composite has declined modestly in recent months, despite a modest advance in large capitalization weighted indices such as the S&P 500. The resulting "basis spread" of a few percent between indices with broad representation and the S&P 500 is a key reason that a disproportionate number of equity mutual funds underperformed the S&P 500 index in 2014. Given our presently hedged investment stance - long a broadly diversified portfolio of individual stocks, offset with hedges in the Russell 2000, Nasdaq 100, and primarily the S&P 500 - this basis spread accounts for a modest retreat in Strategic Growth and Strategic Dividend Value, despite market volatility that has been very much as expected in recent months.
The graph on page 1 of the Hussman Funds 2014 Annual Report breaks out the stock selection performance of Strategic Growth Fund, without the impact of hedging, compared with that of the S&P 500. While there is no assurance that this strong record will continue, shorter-term performance gaps are common – especially when the broad market is lagging the large-cap indices. This often occurs when market internals deteriorate in a way that suggests increasing risk-aversion among investors.
In Strategic Total Return, the Fund reduced its portfolio duration in response to the recent retreat in the 10-year Treasury yield below 2%. As of early January, the Fund had a duration of about 2 years (meaning that a 100 basis point change in Treasury yields would be expected to impact the Fund by about 2% on the basis of bond price fluctuations), with a moderately constructive, though not aggressive, position in precious metals shares.
December 8, 2014
As of early December, the Hussman Funds remained strongly defensive toward equities, and moderately constructive toward Treasury bonds and precious metals shares. In the context of rich equity valuations on historically reliable measures coupled with lopsided bullish sentiment (Investors Intelligence reports the percentage of advisory bears at just 13.9%), we observe widening credit spreads between junk bond yields and Treasury yields, and broadening dispersion across trend-sensitive measures of market internals. The full effect of these conditions is indicative of thin and compressed risk premiums in an environment that is subtly shifting toward increasing risk aversion. It’s one thing when risk premiums are compressed but uniformly favorable market action across industries, sectors, and security types suggests the continued willingness of investors to seek and accept risk. It’s quite another when risk premiums are compressed and the evidence suggests that risk aversion is setting in. We believe that this difference is crucial to recognize at present.
Several equity indices reflecting the democratic “rank and file” of the equity market, such as the NYSE Composite and the Russell 2000, peaked on July 3rd of this year, and remain below those highs. The broadly diversified stock holdings of the Strategic Growth Fund have also been roughly flat since early July. Meanwhile, indices dominated by large capitalization stocks such as the S&P 500 and Nasdaq 100 have advanced about 5% and 10%, respectively, since then.
Despite having a very defensive “staggered strike” hedge in Strategic Growth Fund that raises the strike price of the index put option side of our hedges closer to market levels, the overall cost of that defense, in terms of option premium decay, has been quite low in recent months because we’ve had numerous opportunities to lower our strike prices on weakness and raise them on strength – a strategy known as “gamma scalping.” The pullback in the Fund since July traces almost entirely to the difference in performance between the stocks that the Fund holds long and the indices (primarily the S&P 500) that it uses to hedge.
Despite various challenges since 2009 in adapting our methods of identifying market return/risk profiles (which I now view as fully addressed), the stock selection approach of the Strategic Growth Fund has historically outperformed both the S&P 500 and the Russell 2000 by a significant margin since the inception of the Fund (see the graph on page 1 of the Hussman Funds 2014 Annual Report). While there is no assurance that this will continue, shorter-term performance gaps are common – especially when the broad market is lagging the large-cap indices. Notably, our experience at the 2000 and 2007 peaks underscores that when a richly valued, overbought, overbullish market is joined by broadening internal dispersion, the subsequent outcomes for the broad market can be extremely negative.
In short, the growing internal dispersion in the market can certainly produce some short-term discomfort for hedged strategies, as broadly diversified portfolios may not perform in line with large-cap indices that are used to hedge. But in the context of a richly valued market, this internal dispersion significantly strengthens the case for a defensive outlook, and increases the risk of significant equity market losses.
Strategic International and Strategic Dividend Value remain fully hedged as of early December. Despite rich market valuations, an improvement in market internals and a narrowing of credit spreads would reduce the immediacy of our concerns, and could encourage a more constructive stance. We continue to view the U.S. dollar as broadly overvalued relative to the Japanese yen and the Euro, despite concerns about quantitative easing in those countries that has created pressure on those currencies in the shorter run.
Meanwhile, Strategic Total Return maintains a moderately (but not aggressively) constructive stance toward Treasury securities and precious metals shares. Sentiment appears particularly lopsided toward the bearish side in precious metals shares (which often move in tandem with the value of foreign currencies).Overall then, we hold a clearly contrarian view in the face of equity, currency, and precious metals markets that have been pushed to extremes by monetary distortions and lopsided investor sentiment. We remain defensive toward equities, and moderately constructive toward foreign currencies and precious metals. For the equity markets, in particular, this view is supported by the most negative combination of market conditions we identify, including – as Zorba the Greek would say – the “full catastrophe” of rich valuations, lopsided bullish sentiment, overbought price action, deteriorating market internals, and widening credit spreads. A material change in these conditions will change our outlook accordingly.
November 10, 2014
As of last week, market conditions have re-established overvalued, overbought, overbullish extremes that we define among a small subset of historical instances that we identify as a “who’s who of awful times to invest.” Notably, and unlike several instances of similar conditions in recent years, the present instance is coupled with widening credit spreads and still negative market action on our measures of internal dispersion. These conditions suggest that thin risk premiums are presently coupled with a subtle increase in the risk-aversion of investors and upward pressure on those risk premiums. That combination has historically been explosive, on average. While we remain open to a shift in market internals that might at least defer our immediate concerns, here and now we are quite defensive toward equities, and our expectations are pointedly to the downside.
In Strategic Growth Fund, we’ve been quite slow to raise the strike prices of our put options during the rally of recent weeks. That changed on Friday, and we moved those strikes much closer to market levels as conditions shifted back to the most severe subset that we define. Again, we are open to a shift in market conditions that would defer those concerns and move us to a somewhat more neutral view. We’ll take our evidence as it comes.
Strategic International Fund remains fully hedged here. However, given what we view as an “overshooting” advance in the dollar and decline in foreign currencies in response to monetary easing in Europe and Japan, we no longer view the U.S. dollar as a particularly useful “safe haven” currency. We’ve seen a spike depreciation of several percent in foreign currencies in recent weeks, and while Strategic International Fund is hedged against equity market fluctuations, the Fund has still picked up some of that currency impact, which is reflected in the pullback of a few percent in the Fund in recent weeks. In our view, the case that the dollar is the “cleanest dirty shirt” is substantially weaker than often argued, as short-term interest rates are nearly zero across the developed world, and excessive debt burdens are endemic across the globe. On the basis of joint purchasing power parity and interest parity relationships (which consider the value of currencies both as a unit of exchange and as a store of value), we view most developed market currencies as undervalued relative to the U.S. dollar. Still, currency fluctuations are likely to be a source of day-to-day fluctuation in Strategic International Fund here.
In Strategic Dividend Value Fund, the investment approach is structured to have a smaller ability to deviate from a passive investment stance than our other equity Funds, but that has also put us in the position of not being able to encourage new investments in the Fund during what we identify as negative market conditions (due to the 50% limit we placed on hedging). Notably, while we’ve had to adapt to significant challenges in recent years as the market essentially ignored even extreme variants of “overvalued, overbought, overbullish” conditions, we identify few such challenges during periods where market internals – particularly on trend-sensitive measures – are unfavorable. The November 1, 2014 Prospectus for Strategic Dividend Value Fund (and accompanying letter to shareholders) details an updated investment policy, the primary effect being to improve the ability of the Fund to hedge against losses during periods where we assess market action as unfavorable, based primarily on the analysis of price behavior. This will maintain the general “long” bias of the Fund, but without forcing market exposure during periods where even our trend-sensitive measures are unfavorable. What that modification, we can be much more inviting toward new investments in the Fund, regardless of prevailing market conditions, as I view the Fund as more flexible in addressing the most severe market conditions we identify.
In Strategic Total Return, we view conditions as quite favorable for both Treasury bonds (though not credit-sensitive debt) and precious metals shares. In recent weeks, we’ve seen a wholesale liquidation in precious metals shares, which are now about 70% below their 2010 peak, as measured by the Philadelphia Gold Stock Index (XAU). The ratio of the spot gold price to the XAU hit 18.5 on that selloff, far higher than the level of 9 reached during the financial crisis a few years ago, and more than 4 times the historical average. In our view, gold shares are deeply depressed relative to the metal itself (which we believe creates something of a margin of defense even if spot gold was to decline further), and we also view negative real interest rates as supportive. Meanwhile, widening credit spreads suggest increasing risk aversion that we view as favorable toward Treasury securities with less credit sensitivity. Of course, both asset classes carry continued risk, including the potential for loss, but overall, we view conditions as favorable on a historical basis, so Strategic Total Return Fund carries a moderate (though not aggressive) exposure to both here.
In comparing the various Hussman Funds, Strategic Growth Fund has the greatest ability to deviate from a passive investment strategy, including the limited ability to establish leveraged positions or highly defensive staggered-strike hedges by allocating a small percentage of assets in index call or put options. Strategic Dividend Value Fund will generally be hedged to a lesser extent, and will continue to follow a dividend-focused stock selection approach that we believe complements the growth-focused stock selection approach of Strategic Growth Fund. With the focus of Strategic International Fund on global equities, and the focus of Strategic Total Return Fund on investment-grade fixed income securities, bond market alternatives, and inflation hedges, the Hussman Funds offer a complementary set of investment alternatives seeking capital appreciation or total return, with added emphasis on protection of capital during unfavorable market conditions.Having addressed and adapted to the challenges of the half-cycle since 2009, I’m very optimistic as we look toward the completion of the present cycle and those ahead. It is exactly the distortions created by central banks run amok that I believe will create wide market fluctuations and opportunities in the years ahead. Though near-term outcomes remain uncertain, and risk is always present, I feel confident that our value-conscious, historically-informed discipline is well-suited to navigate those opportunities over time.
November 3, 2014
The Hussman Funds remain defensive toward equities, and increasingly constructive toward Treasury bonds and precious metals shares. The combination of rich equity valuations and deterioration of market action across a broad range of market internals (individual stocks, industries, and security types such as high-yield debt) continues to be the primary driver of our defensiveness. Strategic Growth maintains a staggered-strike position that raises the strike prices of the put side of our hedge toward market levels, but we have been slow to raise those strikes, so at present, these positions represent additional put option premium (versus a matched-strike hedge) of only about 1% of assets looking out to year-end. While we could see some decay in the value of those positions if the market advances further, most of the day-to-day fluctuation in the Fund at present is likely to be related to differences in the performance of the stocks held by the Fund relative to the indices we use to hedge (primarily the S&P 500, and to a lesser extent, the Russell 2000 and Nasdaq 100).
In general, the strongest market return/risk profile we estimate is associated with a significant retreat in market valuations that is then coupled with an early improvement in market action on our measures. We strongly expect such conditions over the completion of this market cycle, but we don't observe them at present. In the short run, we anticipate significant continued market volatility as increasing cyclical pressures of overvaluation and deteriorating market internals battle with a very entrenched habit of speculators to view each market decline as an opportunity to "buy-the-dip." This leaves us quite agnostic about near-term market direction (and is one of the reasons we are slow to raise our index put option strikes in response to market gains). As usual, our investment focus remains fixed on the complete market cycle.
In Strategic Total Return, our estimates of prospective return/risk have shifted more favorably toward both bonds and precious metals shares. While we don't anticipate material inflation pressures at present, the prices of precious metals shares are now back to nearly the same levels observed in 1999 when spot gold was closer to $280 an ounce than the current $1170. This places the ratio of spot gold prices to the Philadelphia Gold Stock Index (XAU) above 18 - without exception the highest level in history. This is not at all to suggest that gold stock prices cannot fall further - psychology plays heavily into price swings, and near term deflation fears can certainly overwhelm longer-term value considerations. Still, we don't view gold stocks as appropriately priced solely on views about near term inflation pressures, and with the XAU down 72% from its 2010 highs, we generally view weakness as an opportunity for a conservative amount of accumulation. In the short run, even a 15% allocation of to precious metals shares can produce, for example, a 0.75% loss on a day when the XAU itself is down 5% (as occurred last week), but we presently view these shares as extremely depressed relative to the metal, allowing some amount of defense, in our view, even if the metal declines further in price.
October 27, 2014
The Hussman Funds remain defensive toward equities, and modestly constructive toward Treasury bonds and precious metals shares. The combination of rich equity valuations and deterioration of market action across a broad range of market internals (individual stocks, industries, and security types such as high-yield debt) continues to be the primary driver of our defensiveness. In general, the strongest market return/risk profile we estimate is associated with a significant retreat in market valuations that is then coupled with an early improvement in market action on our measures. We strongly expect such conditions over the completion of this market cycle, but we don't observe them at present. In the short run, we anticipate significant continued market volatility as increasing cyclical pressures of overvaluation and deteriorating market internals battle with a very entrenched habit of speculators to view each market decline as an opportunity to "buy-the-dip." As usual, our investment focus remains fixed on the complete market cycle.
The foregoing commentary seeks to describe the general investment stance of the Hussman Funds as of the date of each comment, and is provided for informational purposes only. None of the foregoing content should be construed as a recommendation of any kind. Although the adviser believes it has a reasonable basis for opinions or views expressed, actual results may differ, sometimes significantly so, from those expected or expressed. Any investment positions discussed in these notes are specific to the date indicated, and may no longer be held by the Funds. The opinions of the adviser with respect to any security or the financial markets may change, without ongoing notice, at any time. A complete record of the investment positions held by the Hussman Funds is provided in the annual and semi-annual Fund reports. Additional or more frequent commentary relating to Fund positions is provided at the discretion of the advisor.
Prospectuses for the Hussman Strategic Growth Fund, the Hussman Strategic Total Return Fund, the Hussman Strategic International Fund, and the Hussman Strategic Dividend Value Fund, as well as Fund reports and other information, are available by clicking "The Funds" menu button from any page of this website.
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