The folly of financial inflexibility
In early 2009, the financial press was dumping praise on any mutual fund manager who had evaded a bulk of the stock market decline. These managers were lauded as heroes, visionaries with the keen insight to see that the worst market and economic environment for 80 years had been just around the corner.
Fund managers who moved portfolios to defensive positions saw their trailing performance shoot up relative to a declining S&P 500. Praise rained down on these apparent savants and fund flows followed. One of the most famous of these managers was John Hussman. A Ph.D. economist from the University of Michigan turned portfolio manager, Hussman’s flagship (Hussman Strategic Growth) fell only -9.02 percent in 2008 when the S&P 500 dropped -37.00 percent. It was even positive early in 2009 as the market continued to drop. As a result, Hussman gained notoriety.
Somewhat bizarrely, Hussman turned from being bullish in late 2008 to rampantly bearish in early 2009 after the Federal Reserve and U.S. Treasury took action in the public marketplace. Here’s Hussman in November 2008:
With the S&P 500 down nearly 40 percent from last year’s highs, and now trading modestly above 10 times last year’s peak earnings level, I continue to view stocks as somewhat undervalued, in that long-term investors can expect the S&P 500 to deliver total returns in the area of 10 percent annually over the coming decade. This is the largest expected return premium, relative to long-term Treasury yields, since the early 1980’s.
And here’s Hussman in April 2009, after stocks had fallen even further:
I recognize that given the depth of the recent decline, it seems as if stocks must be at once-in-a-lifetime valuations. Unfortunately, this is an artifact of the previous level of overvaluation. The depth of a bear market often has a loose relationship with the extent of the prior bull market (and particularly with the level of valuation of the prior bull), but there is very little relationship between the depth of a bear market and the subsequent bull…
The only way that stocks could be considered extremely undervalued here is if we assume that the record profit margins of 2007 (based on record corporate leverage) are the norm, and will be quickly recovered. While we never rule out the potential for surprising strength or weakness in the markets or the economy, the assumption that profit margins will permanently recover to 2007 levels is equivalent to assuming that the past 18 months simply did not happen.
What got to Hussman? His academic background and politics. I can’t think of another answer. Hussman dismissed mean reversion, dismissed the fact that long-term corporate profit growth is the norm and dismissed his own comments about valuations in a desperate need to dig his heels in about centralized monetary policy in the US. For five years running he has been signing the same tune: the economic and market recovery is temporary and “false” and only exists because of “propping up” by central banks.
Go ahead and read every single one of his weekly market commentaries. What you’ll see is that Hussman grabs hold of any data point that reinforces his narrative: the economic and market recovery is a sham and due to collapse at any moment. In November 2009 it was housing. In February 2010 it was employment reports. In May 2010 it was currency debasement. In July 2010 it was double dip recession and a likely bubble (at S&P 500 1100). By 2011 Hussman could not let go of his fears over central bank activity. QE was going to bring certain doom, end of story.
How did this narrative affect the Hussman Strategic Growth Fund?
The fund has been crushed by the S&P 500 every year since 2009. It even managed to lose money in 2010, 2012, 2013 and YTD 2014 despite the market being positive. Over the 5-year period ending 7/31/2014, the fund had an annualized return of -5.42 percent. That’s -5.42 percent per year, compared to the S&P 500’s +18.83 percent. Even if we go back 10 years to include the fund’s outstanding performance in the bear market, it is still down -1.30 percent per year for the decade. Since investors have terrible timing of when they choose to invest with managers, the average investor return over the past decade is even worse at -3.27 percent.
Look. This is about Hussman, but it’s also not. It is also about how treacherous it can be to allow a powerful narrative to take over your investment decisions. Hussman claimed in a 2009 WSJ piece “I don’t think you can forecast what the market will do,” he says. “But you can know the kind of market you’re in, and make decisions accordingly.”
He was either 1) lying about trying to forecast the market or 2) wildly wrong about what kind of market we’ve been in. It doesn’t really matter which was true. He was driven by his narrative, held down by his convictions and paid a huge price in his portfolio. (It’s worth noting that Hussman has publicly claimed to have a significant portion of his net worth in the fund, and a large stake was verified by Morningstar recently).
I do not remotely doubt that John Hussman is smarter than me by every measure. He will also eventually feel vindicated when the next market correction comes. Given the fund’s 33 percent short position in an S&P 500 futures contract (as of 7/31/14) I imagine it will hold up quite well. But the fund’s shareholders have paid a huge price in holding out hope that the narrative will come to fruition.
Perhaps there is no such thing as a “forecast-free” investment approach (as even a simple indexing strategy is biased towards long term economic and corporate profit growth). But being gripped so tightly by a story you tell yourself about the world, especially a pessimistic one, is a dangerous way to make long-term investments.