The following is an excerpt from John Hussman's annual letter to shareholders, which was published this week. Mr. Hussman is the president of the Hussman Trust and manager of the Hussman Strategic Growth Fund. For the full annual report, click here.
I continue to be concerned about credit conditions and the underlying fundamentals of the U.S. economy. In recent months, fresh deterioration in leading economic measures, narrowing compensation for credit risk, and rich stock market valuations have increased the vulnerability of equities and corporate bonds to price weakness. These concerns are reflected in the restrained exposure to risk that the Hussman Funds presently accept.
While the potential for further credit and economic strains remains evident, I clearly underestimated the extent to which Wall Street would respond to a modest economic rebound in 2009, driving stocks to the point where they were not only overvalued again, but strikingly dependent on a sustained economic recovery and the achievement and maintenance of record profit margins in the years ahead.
Meanwhile, near-zero yields on default-free Treasury bills and bank deposit instruments provoked investors to accept a great deal of credit risk as 2009 progressed, to the point where credit spreads (the difference in yields between risky debt and Treasury securities) narrowed to the lows seen just prior to the recent crisis.
Given that GDP growth over the past year has amounted to $563 billion, while Federal government debt has increased by $1.6 trillion, there appears to be little evidence that the positive economic growth of recent quarters was driven by much else but the deficit spending of government and to a lesser extent, the aggressive purchase of mortgage securities by the Federal Reserve.
Private sector demand, income less government transfer payments, employment growth, housing activity and other measures of “intrinsic” economic activity remain remarkably weak. With the impact of stimulus spending trailing off, and little evidence that debt has been restructured in proportion to the cash flows available to service that debt, expectations for economic expansion appear to be based more on hope than on a careful reading of economic history.
Except for a recent burst of inventory rebuilding that appears complete, the big-ticket, credit-financed expenditures that have historically driven cyclical expansions are still dormant.
I continue to believe that at present valuations, exposure to market risk and credit risk is not likely to be well compensated over the long-term, and may be associated with substantial losses in the intermediate term. Currently, we remain unable to rule out the likelihood that the recent advance is simply a fragile post-crisis bounce, similar to those following other historical credit crises in the U.S. and abroad.
