January 3, 2011
Setup and Resolution
John P. Hussman, Ph.D.
Happy New Year. I’d like to begin this week’s update with some investment comments specific to the Strategic Growth fund, and then move on to conditions that we expect to influence the markets in 2011.
Through mid-September of 2010, the stock market was essentially a roller-coaster with no net gains for the year, but the final months saw a speculative burst that was heavily skewed toward cyclicals, small-caps, commodities, and shares characterized by low stability of earnings and high sensitivity to market risk. The Strategic Growth Fund finished the year with a slight loss of 3.62%. The loss resulted from our defense against an overvalued, overbought, overbullish, rising-yields condition coupled with a runup in risk assets that was still uncorrected as the year came to a close. While the decline was minor from a long-term perspective, it felt excruciating in the final weeks of 2010, as stocks characterized by low-quality, low yield and high risk persistently outperformed those ranked higher in quality, yield and stability. The result was a series of small but relentless day-to-day pullbacks in the Fund, while the major indices registered a series of marginal new highs for the year.
We enter 2011 at a point where investors have pushed risk assets to a speculative extreme, on the belief that the Fed has provided a “backstop” against losses. While there’s no assurance that we won’t see a further extension of this over the short-term, we’ve found more often than not that speculative setups in the financial markets are followed by a striking degree of subsequent resolution in the opposite direction.