Middle of the Road

I stopped reading Hussman regularly about a year ago. His pieces are not conducive for a good night's sleep—a a statement which may come back to haunt me—but mostly, just because he has been wrong for so long that I simply lost interest [1]. His latest article, however, is worth reading in its entirety because it is one of the few pieces I have read in a while that excellently captures the frame of mind of investors at the moment. 

I will let John speak for himself; 

Several years of persistent yield-seeking speculation provoked by zero-interest rate monetary policies have created a fertile ground for cognitive dissonance. On one hand, any observer with historical perspective knows not only that the overvaluation from this kind of speculation inevitably ends in tears, but also that the heavy issuance of new speculative and low-quality securities during the bubble finances and enables unproductive malinvestment that leaves the economy far worse off in the end. We should recognize that this same narrative was observed in the late-1920’s bubble-crash, in the tech bubble-crash, in the housing bubble-crash, and will be remembered painfully, but in hindsight, as the QE bubble-crash. On the other hand, prices have been advancing.

Presumably, Mr. Hussman is talking about U.S. equities here since I can certainly come up with a number of markets where prices have not been advancing. And herein also lies the rub. In the current investment enviroment, there seems to be only two options. If you are in the upbeat corner, you believe in the trend and that Spoos will recover swiftly from every 5% correction and you act accordingly (probably with a nice dollop of leverage). The alternative is the seventh ring of hell, where a catastrophic 50-70% drawdown lurks just around the corner. The ability to say "I f*cking told you so" and the prospect of the warm fuzzy feeling of being able to deploy cash at firesale valuations outweigh the short-term pain of being short, in cash, or long vol since 2011 in what has, arguably, been one of the most steady and strong bull markets ever in U.S. equities.

My problem is that I don't like either, and I wonder whether both could be wrong. Consider for example a scenario in which the S&P 500 trades sideways this (with volatility), but equities in down-trodden Chile, Brazil, Eurozone bank sector, energy (etc) offer outperformance, or even, decent absolute returns. I think we have to, at least, entertain the notion that when it comes to the current investment environment, sector and country rotation represent the "X" that marks the destination for outperformance. Sometimes, the middle of the road is not such a bad place [2].

Portfolio notes: 

Not much to report. It has been an altogether volatile start to the year with the biggest position (KGF) seeing a rather unpleasant retracement after having some real legs into the end of last year. We remain convinced, however, that it can push higher in the first quarter. Elsewhere, the gold and US treasury position are providing a little bit of relief, and the upbeat earnings release from RSW was also a positive surprise. In the long-term part of the portfolio, we have exploited recent weakness to open up a position in Malaysian equities. We expect to do the same with Brazil and Chile towards the end of February. Cash balances remain about 20%, and the poor start to the year for risk assets is not enough for us to up this ratio ... for now! 


[1] - The flipside here is of course that Hussman is one of the few investors out there who sticks religiously to his framework, and for that he has my unwavering respect. But for the average investor (professional or retail) following his advice has been extremely costly (no matter what happens next). 

[2] - Polemic appears to have the same story; I agree completely with this narrative. If you haven't bookmarked this blog, by the way go do it.