Goat Rodeo - Appalachian slang for a chaotic, high-risk, or unmanageable scenario requiring countless things to go right in order to walk away unharmed.
Over the years, of the most frequent phrases in these weekly comments has been "on average." Most of the investment conditions we observe are associated with a mix of positive and negative outcomes, so rather than making specific forecasts about future market direction, we generally align our investment position in proportion to the average return/risk outcome, recognizing that the actual outcome may be different than that average in any particular instance.
Once again, we now have a set of market conditions that is associated almost exclusively with steeply negative outcomes. In this case, we're observing an "exhaustion" syndrome that has typically been followed by market losses on the order of 25% over the following 6-7 month period (not a typo). Worse, this is coupled with evidence from leading economic measures that continue to be associated with a very high risk of oncoming recession in the U.S. - despite a modest firming in various lagging and coincident economic indicators, at still-tepid levels. Compound this with unresolved credit strains and an effectively insolvent banking system in Europe, and we face a likely outcome aptly described as a Goat Rodeo.
My concern is that an improbably large number of things will have to go right in order to avoid a major decline in stock market value in the months ahead. We presently estimate that the S&P 500 is likely to achieve a 10-year total return (nominal) of only about 4.7% annually, which reduces the likelihood that further gains will be durable even if they persist for a while longer. In the context of present valuations and a probable Goat Rodeo in the months ahead, my impression is that the recent market advance may be a transitory gift.
Market Climate
As of last week, the Market Climate for stocks was characterized by conditions we associate with a "whipsaw trap," coupled with overvalued, overbought, overbullish conditions and evidence of exhaustion that has only a handful of generally awful historical peers. Strategic Growth and Strategic International remain tightly hedged, though in both funds, we've clipped a few percent from our hedges to reflect the more defensive composition of our holdings. Though steep market declines tend to be indiscriminate (with even defensive stocks often acting as if they have a beta of 1.0), we recognize that "risk on" days can also be very uncomfortable when defensives lag the market and our hedges bite with full force. The modest change to our hedge is intended to maintain our downside protection while hopefully producing a little bit less day-to-day discomfort on days when Wall Street suddenly goes "risk on" and chases banks, financials, materials, and high-debt cyclicals, all of which we hold with smaller weight than the major indices reflect. Overall, however, we would still characterize our investment position as strongly defensive.
In Strategic Total Return, we're seeing some moderate shifts in the Market Climates for bonds versus precious metals. We used last week's weakness in bonds to increase the duration of the Fund toward a still moderate 4.5 years, while using the strength in precious metals shares to clip back our holdings below 10% of assets. Given the volatility of precious metals shares relative to bonds, the overall effect is to move the Fund to a somewhat more conservative stance, in the sense that day-to-day volatility is likely to be lower than it has been with a more significant precious metals position. While the Market Climate for precious metals shares remains positive, we observed a discrete reduction in our projected return estimates, and are aligning our investment stance proportionately.
http://www.hussman.net/wmc/wmc120130.htm
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