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Entries in Hussman (2)


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. 


Random Shots - The Bad Bank is Dead, Long Live the Bad Bank

Most of the sell side macro research that I have been sifting through this week is pretty constructive on the future which always makes me worry. Still, it is difficult to not agree a little bit with the point that if, indeed, the world is not ending there is still a lot of cash on the sidelines that can get sucked in on this rally. 

In principle I agree with Steen Jakobsen's latest views that the upside is strongly driven by the global QE put and low holiday volumes. Hope of policy intervention as the market grinds up and beyond new highs usually is bad sign. Still, as a macro guy I should also point out following for example the latest from Simon Ward that the macro data has indeed improved. For one, investors should note that emerging economies have been slowing down to a grinding halt for 12 months and are likely already turning up from a bottom. In the US, the continuing revival in residential and commercial construction  is real and starting from a low point which suggests that more upside surprises are possible here. 

The problem though is that the amount of conflicting information right now is dizzying and against a backdrop of a continuing fear of the end of the workd, this creates and even more binary and frustrating world for investors. Hussman for example believes we are on the verge on a major inflection point. 

We are presently in an environment that has historically been associated with the overvalued segment of late-stage bull markets. This segment of the market cycle has been frustrating for us before, and that frustration may not be over. Yet in each instance, our defensiveness was overwhelmingly vindicated. The drum-beat of investors is that “this time is different.” Simply put, I doubt that this time is different.

With that in mind, my base case remains that the scope for a choppy upward movement of the equity market is not yet exhausted and, consquently, that complacency and euphoria can get much more extreme. 


The Bad Bank is Dead, Long Live the Bad Bank

Investors have only slowly been given information on the Spanish bailout which was (in)formally announced back in the beginning of July with €100 billion for the banks. By the letter of the law, Spain has not yet requested for aid and despite the ECB's verbal intervention outright ECB financing of Spanish deficit spending will require full Troika programmes. 

So far then, it is difficult to know whether to laugh or cry at the news that Economy Minister Luis de Guindos and the government has apparently decided to create a new bank just months after the other bad bank (Bankia) went belly up. 

Quote Bloomberg

Spain will put its bank rescue fund in charge of the bad assets separated out from the nation’s struggling lenders that are receiving a European bailout. The FROB fund will be the main shareholder in a so-called bad bank, according to a proposal that will be approved by the Cabinet on Aug. 24, Economy Minister Luis de Guindos told the Efe news agency in an interview today.All the banks receiving loans from European rescue funds will have to transfer their non-performing assets to the bad bank, he said. The comments were confirmed by a Spanish official, who asked not be identified, citing government policy.

You seriously cannot make this up, but the only difference now is that it will be easier to add the liabilities to the Spanish sovereign since, sooner or later, the FROB itself will have to be bailed out. Of course, Spain may ask for an official bailout long before that and then the transformation will be complete. Losses in the Spanish construction and RMBS industry will have migrated from one consolidated bad bank balance sheet to another, on to the sovereign and finally into the heart of the Eurosystem. 

This process has been clear for a long time what hasn't has been the speed and twists and turns for us to get there. Speaking of twists and turns, the news coming out of Germany (apart from a rapidly slowing economy) is also mixed with Merkel apparently fighting other members of the government on whether to cut Greece some slack all the while that Der Spiegel apparently is reporting that the ECB is going to cap yields in the periphery. 

Until action proves otherwise, the base case remains that the ECB will refrain from strong intervention until memorandums of understandings have been signed, but Spain and Italy are big fish compared to Greece. Their respective governments know that they could bring the euro down and inflict mortal damage to Germany. It is difficult to see exactly what the position of Germany is here, but one is certain , Germany (and all other so-called safe havens) have benefitted from the ongoing euro crisis charade in that it has been significantly cheaper for them to borrow. Italy and Spain could merely be seen as asking Germany to pay for this privilege.

Ultimately though the market will call Italy and Spain on their bluff and the onus will be on the ECB to do just enough to keep the boat afloat, but not so much as to be seen caving in to guerilla tactics. This is already an incredibly difficult minefield for the ECB to maneouevre and it won't get easier as the recession intensifies.  The end result is that losses will increasingly be mutualised and this may, in the end, make it more palpatable for the ECB to engage in outright monitisation.