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Twelve answers to John P. Hussman's Financial QUIZZ

  • Free Thinker @Moorea


John P. Hussman owns a Master's Degree from Northwestern University (1985), and a PhD from the Leland Stanford Junior University (1992) and runs a series of investment funds, the flagship of them being the HSGFX, and offers an instructive weekly market comment on his web site hussmanfunds. In March 2012, John P. Hussman was looking to recruit an Advisor Relations Manager and issued a financial QUIZZ comprising twelve questions for any applicant. I had been reading his weekly market comments for many years and appreciated the logic and steadfastness of the opinions and analysis exposed in his papers and even though I had no intention to postulate as my life is across an ocean, I thought intellectually stimulating to embark on answering to my best the QUIZZ.
Twelve answers to John P. Hussman's Financial QUIZZ
Patrice Poyet
Poyet's Real Estate & Investments Returns
5, av Corniche d'Azur, 06100 Nice, France.
John P. Hussman owns a Master's Degree from Northwestern University (1985), and a PhD
from the Leland Stanford Junior University (1992) and runs a series of investment funds, the
flagship of them being the HSGFX, and offers an instructive weekly market comment on In March 2012, John P. Hussman was looking to recruit an
Advisor Relations Manager and issued a financial QUIZZ comprising twelve questions for any
applicant. I had been reading his weekly market comments for many years and appreciated the
logic and steadfastness of the opinions and analysis exposed in his papers and even though I had
no intention to postulate as my life is across an ocean, I thought intellectually stimulating to
embark on answering to my best the QUIZZ.
1) Why does each of the Hussman Funds have the word "Strategic" in its name?
A strategy is a plan of action designed to achieve a vision. Hussman’s Funds deserve this term
for at least two reasons: first they implement a distinctive plan (i.e. the strategy) characterizing
each of the Funds and that plan addresses an entire market cycle, therefore aiming at a long
objective (i.e. strategic) as opposed to shorter term plans (i.e. tactical).
To illustrate that definition, one may consider two of the Funds (i.e. the strategic growth and the
strategic total return) and briefly describe their corresponding strategies.
The goal of the Strategic Growth Fund goal is to outperform the S&P 500 Index over the
complete market cycle (bull market peak to bull market peak, bear market trough to bear market
trough), while having smaller periodic losses than a passive investment strategy. In that respect
the manager has a stringent stock selection process based on a discounted cash flow criterion
and hedges the portfolio as deemed appropriate according to the market climate. We could refer
to such a strategy as a “Hedged Long” but not necessarily as an Absolute Return approach in the
sense that it compares the results obtained to the S&P 500 Index over the complete market
cycle. The stock selection process currently leads for example as of June 30, 2010 to an over
representation of Health Care (30.8%), Consumer Discretionary (22.8%), Information
Technology (16.0%), and Consumer Staples (16.0%) and a small participation into Energy
(2.2%), Industrials (2.0%), Financials (0.5%) and Materials (0.1%). Hedges are established
thanks to option combinations (long put option, short call option) on the S&P 500 Index, on the
Russell 2000 Index and on the Nasdaq 100 Index. Each option combination behaves as a short
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 1/23
sale on the underlying index, with a notional value of $100 times the index value. Whenever the
market climate is adverse, the manager can hedge a considerable proportion of the Fund (e.g.
hedging up to 99.16% as of June 30, 2010 of the total value of the Fund’s long investment
positions in individual stocks). As described by Hussman himself, In that case “the overall
returns on a hedged investment position can be expected to be driven by several factors. First, a
hedged position earns the difference in performance between the stocks it holds long (after
expenses) and the indices it uses to hedge. In addition, because of the way that options are
priced, the combination of a put option and a short call option acts as an interest-bearing short
position on the underlying index and delivers implied interest at a rate close to short-term
Treasury yields”.
The Strategic Total Return Fund is designed for investors who want to participate in the fixed-
income markets for income and capital appreciation, with added emphasis on the protection of
capital against interest rate volatility and inflation during unfavourable market climates. The
Fund's principal investment strategies emphasize strategic management of the average interest
rate sensitivity (i.e. "duration") of portfolio holdings (e.g. a 3 years duration implies a
fluctuation of 3% of the Fund’s NAV as a response to a 1% variation of the general level of the
interest rates), the adjustment of the Fund's exposure to changes in the yield curve and allocation
among fixed-income alternatives and inflation hedges. The two most important dimensions of
the strategy consider "valuation" and market action, whereby favourable valuation means that
yields on long-term bonds appear reasonable in relation to inflation, short-term rates, economic
growth and yields available on competing assets (e.g. utilities delivering high and regular
dividends, foreign bonds, etc.) Moreover, diversification in precious metals stocks or foreign
bonds are favoured when real US rates (i.e. nominal minus inflation) are declining relative to
real foreign interest rates (configuration which normally goes along with a weakening USD).
Various strategies for hedging interest rate risk (especially on long term bonds) are
implemented, including the purchase of put options and writing of call options on Treasuries,
knowing that the total notional value of such hedges (i.e. the dollar value of Treasuries
represented by these options combinations held by the Fund) will not exceed the total value of
the bonds held by the Fund with a remaining maturity of 5 years or more (fully hedged in case
where it equals).
2) Consider three investment strategies: Long only, Absolute Return, and Bear Market
strategy. Compare and contrast the Strategic Growth Fund's strategy with each of these.
What performance metrics are appropriate for each strategy, what are their drawbacks,
and how are they calculated?
A long only strategy would purchase securities, whatever be they depending on the trading
universe selected, and would keep these securities over the investment horizon selected. The
simplest such strategy could even be referred to as a buy and hold approach where the investor
makes an initial selection and keeps with it whatever happens. Normally Long only strategies
would vary exposure according to some criteria be they technical (e.g. hoping to capture some
increasing momentum) or fundamental (e.g. lightening positions when market valuations
increase and reversely). As compared to such a Long only approach the Strategic Growth Fund
approach will not only vary exposure over time, by an ever rolling stock selection process but
will also adjust the net exposure to the market conditions by hedging more or less the portfolio
according to the future expected returns that the market can deliver. This is based on a well
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 2/23
benchmarked methodology that compares estimated returns as computed by various discounted
cash flow techniques to real returns as measured over a very long period of time (i.e. back to
1929). As stated by Hussman “For investors who can vary their market exposure in response to
changes in expected returns, the variation in expected returns constantly creates new
opportunities over time, some having greater risk than others, but forgiving of risk-management
provided that steep losses are avoided. We've outperformed the S&P 500 over every complete
market cycle (bull and bear market combined), with smaller periodic losses, since the inception
of the Strategic Growth Fund, and we remain ahead of the S&P 500 since its 2007 peak.”
Absolute Return differs from relative return because it is concerned with the return of a
particular asset or portfolio thereof and does not compare it to any other measure or benchmark.
In general, a Fund seeks to produce returns that are better than its peers, its fund category,
and/or the market as a whole. This type of fund management is referred to as a relative return
approach to fund investing. An absolute return fund seeks to make positive returns by
employing investment management techniques such as short selling, futures, options,
derivatives, arbitrage, leverage and unconventional assets that should ensure a positive return
whatever market conditions. They are sometimes referred to as “Market Neutral Investing” like
in Joseph G. Nicholas book with special emphasis on Long / Short hedge funds strategies.
Hussman’s Funds implement many of the techniques deployed by Absolute Return approaches.
The Strategic Growth Fund hedges its portfolio by sophisticated combinations of options and
varies exposure and hedges according to a proprietary methodology whereas the Strategic Total
return Fund uses various fixed-income arbitrage techniques often used by Absolute Return
players, such as the management of the average interest rate sensitivity (i.e. "duration"), the
adjustment of the Fund's exposure to changes in the yield curve and implements various hedging
interest rate techniques including but not limited to the purchase of put options and writing of
call options on Treasuries, Nevertheless, none of these two Funds could be referred to as pure
“Absolute Return” players as the “Strategic Growth” uses the SP500 as a benchmark and the
“Strategic Total Return” compares its performance to the Barclays Capital U.S. Aggregate Bond
A Bear Market Strategy would try to deliver consistent positive returns when an entire market
declines. The simplest technique one can mention resorts to single underlying securities and be
an inverse replication of an index, security or currency. Considering simple products as
examples, UDN replicates the performance of being short the US Dollar against the Euro,
Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc, whereas SH
seeks daily investment results that correspond to the inverse of the daily performance (-X1) of
the SP500 index. In the aforementioned examples and given the means used, nothing ensures
that the result claimed could be extended for instance to longer periods of time, and is more
often than not the case (e.g. SH will not inversely replicate SPY over longer periods of time
than one or a few days and is therefore a very imperfect hedge of SPY) this being aggravated by
leverage (-X2 or –X3). Nevertheless, these ETFs products can be used, together with shorts of
various natures (e.g. stocks, ETFs whenever possible, futures) or combinations of options to
implement a more complex Bear Market Strategy. These products do not address the difficult
questions as they will simply loose money whenever the market moves adversely, i.e. rises.
They have a limited objective and cannot be referred to as strategies in themselves. A Bear
Market Strategy would deliver value when the market tanks and preserve it when facing an
adverse move and will have to implement more sophisticated criterions. Determining what
characterizes a bear market, when to open positions, how long to keep them as the more
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 3/23
successful the short is the more the gains are eroded (e.g. when the position has already lost
50% - which seldom happens, a -2% move is just a 1% nominal profit), all these are
components of a true Bear Market Strategy. We’re not going to delve into more details but will
now briefly compare the Strategic Growth Fund's strategy to these Bear Market Strategies by
observing that the objective is not to deliver positive returns in a bear market but to limit the
drawdown experienced by the Fund. To that aim the Fund hedges its portfolio and the more
adverse the valuations are the more the Fund is hedged. Valuations can be assessed by various
means, a very straightforward one being the expected returns delivered by a given market over a
given period of time.
As explained by Hussman in wmc100802 - Valuing the S&P 500 Using Forward Operating
Earnings: “the long-term annual total return for the S&P 500 over any horizon T can be written
Long term total return = (1+g)(future PE / current PE)^(1/T) - 1
+ dividend yield(current PE / future PE + 1) / 2
The first term is just the annualized capital gain, while the second term reasonably approximates
the average dividend yield over the holding period. For the future P/E, one can apply a variety
of historically observed P/E ratios in order to obtain a range of reasonable projections, but the
most likely outcome turns out to be somewhere between the historical mean and median. You
have to get two things right: the "normal" future P/E and the prospective long-term earnings
growth rate g. Very simply, looking out over a 7-10 year horizon, the proper historical norm for
price-to-forward operating earnings is approximately 12.7. Moreover, one cannot simply apply
the long-term operating earnings growth rate of 6.3% (0.063) as an unchanging measure of g.
Rather, an accurate growth rate for the model has to reflect the level of profit margins at any
point in time, since the current P/E multiple may reflect either depressed or elevated earnings.
For a 10-year investment horizon, the proper value of g should take into account the gradual
normalization of margins. Historically, the best estimate is approximately:
g = 1.063 x (0.072 / (FOE/S&P 500 Revenues))^(1/10) - 1
End of quote.
Given the expected returns leading among other factors to an assessment of the valuation of the
market and various other parameters such as market participation (e.g. over sold/bought, over
bearish/bullish), expected rates moves, market internals (e.g. advances / declines) etc. a level of
protection of the portfolio (0 to 100%) is determined and corresponding hedges put in place.
The major objective is to be more market responsive than any of the strategies we have to
compare the Strategic Growth Fund to and essentially to limit drawdown what none of the other
three strategies directly address.
Not going into a lot of details one can mention the following possibilities with respect to
performance metrics of the three Long only, Absolute Return, and Bear Market strategies
beyond comparing them to reference indexes. In fact, several classical notions such as the
Alpha, Beta, Sharpe Ratio or Value at Risk can be used to measure various characteristics of
different strategies. Simply put, Alpha measures the return in excess of the compensation for
the risk borne, Beta is a number describing the relation of the returns with those of the financial
market as a whole (typically a Bear Market Strategy should have a negative Beta) and the
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 4/23
Sharpe ratio is used to characterize how well the returns compensate the investor for the risk
taken, the higher the Sharpe ratio number the better. The value at risk VaR resort to a more
probabilistic approach and reports the probability for a given portfolio over a given period of
time (often daily VaR) that a given maximum loss be met or exceeded. It can be used as an
estimation of the maximum loss that should be encountered on a diversified portfolio bearing
exceptional circumstances.
Nevertheless, a key factor is seldom taken with the proper consideration, i.e. drawdown. The
drawdown measures the loss experienced from a “peak to through” and corresponds to the
worse feeling of an investor as the maximum NAV is too often considered as “locked in” at
least mentally. Therefore, money lost from the peak to the trough is considered by the client as
lost by the manager (which is not entirely wrong) even though they would have been unrealized
capital gains previously made by the manager. This perception is in any case not absent of
justifications as will be developed in section 8, simply because severe drawdowns are extremely
difficult to weather off as for example a loss of 50% requires to further make a 100% gain just
to break even. In fact one can assert that beyond various performance measurement criterions
all investment journeys are certainly not equal, depending on the volatility of the portfolio or
Fund and the maximum drawdown it experienced. In fact, many if not most individuals engaged
in simple buy and hold strategies and who are further pushed to get in during a distribution
phase by wall street are later giving up with big losses as the drawdown and volatility they
experience are simply unbearable. Therefore, Hussman Funds offer beyond classical
performance metrics the key advantage of limiting drawdowns and corresponding volatility
thanks to the implementation of appropriate hedging strategies at the expense of only a marginal
loss of performance (i.e. hedges and their cost limiting somehow participation in overvalued,
overbought markets).
3) Discuss your understanding of the concept of Market Climate. Discuss how this
framework differs from a buy and hold approach.‐ ‐
The concept of market climate aims primarily at determining the conditions of a level of raw
participation (i.e. un-hedged) of the fund in the market and eventually the appropriate hedges to
minimize the risk while keeping corresponding costs at bay. Of course the notion of market
climate differs for stocks (Strategic growth) and bonds (Strategic Total Return). Starting with a
universe of stocks and as described in the following weekly market comment “Wmc110502”,
four major notions play important roles in assessing a “Market Climate”: determining the
valuation of the market, the involvement of market participants, the sentiment of the market
participants and the perspective on rates and yields on 10 years treasuries (^TNX).
Of course, other factors can play a role not limited to but worth mentioning are market internals
(e.g. advance decline measures) and macroeconomic perspectives such as the probability of an
oncoming recession based on several indicators (e.g. an abrupt plunge in consumer confidence,
negative real interest rates, an ISM index below 54, a decline in aggregate weekly hours versus
a quarter earlier, year-over-year growth in non-farm payrolls less than 1%, and six-month
payroll growth less than 0.5% etc.).
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 5/23
Let’s focus now on the four major items determining the notion of “Market Climate”:
a) Valuation: Assessing the valuation of a market is a key requirement. Shiller P/E (which uses
a 10-year average of inflation-adjusted earnings) are a simple but historically informative way
of quickly assessing the valuation of a market, noting that Shiller P/E over 18 indicate an
overbought market. Hussman’s methodologies based on earnings, forward earnings, dividends
and other fundamentals, all which have a fairly tight relationship with subsequent 7-10 year
total returns have been briefly mentioned in section 2 of this paper and are most informative.
Valuations are mainly addressed from the standpoint of the discounted cash flows that are likely
to be delivered to investors over time. These include our variant of the Barsky-DeLong model
(presented in Don't Discount Discounted Dividends, and the realized payout model that I
presented in The S&P 500 as a Stream of Payments. The market can be categorized to simplify
as over valued, fairly valued, favourable or even at a discount price. A simple chart of the
SP500 using a semi-log scale and appropriate calibrated channels is also visually informative.
b) Market participation: Determining whether a market is oversold, neutral or overbought is
an important information, though with a shorter term usage than its intrinsic valuation. For
instance, an overvalued market can be locally oversold but this does not represent though a
major investment opportunity. A manager could decide in that case of some increased
participation, with appropriate hedges and as long as market internals would show some
improvement. To give an example of an overbought market, one can assert that whenever an
index as the S&P 500 is within 1% of its upper Bollinger band on a daily, weekly and monthly
resolution (20 periods, upper band 2 standard deviations above the moving average), and stands
at least 20% above its 52-week low, this market is overbought.
c) Market sentiment: Market sentiment indicators are informative of the complacency or of the
fear of market participants, they are typically contrarians. Classical such indicators are odd-lot
transaction volumes, put-to-call volume ratios, volatility showing complacency of uninformed
participants at market tops and extreme fear at market bottoms, among others. For example,
investors Intelligence bullish sentiment of at least 45% and bearish sentiment less than 25% is
typical of an over-bullish environment.
d) Yields: Rising yields, e.g. on the 10-year Treasury and the Dow 30 Corporate Bond Average,
standing above their levels of 6 months earlier is an ominous sign for several reasons (yield and
price have an inverse relationship, i.e. yields rise when the bond price decreases).
Beyond any given market climate, a sound stock selection process must be at work such as
favouring securities offering predictable long-term cash flows, reasonable valuation, consistent
growth, and margin stability.
But at any given point in time, as indicated in “wmc091214”, one can make an assessment of
the future expected returns to be delivered given the current valuation of a market. Again I will
quote Hussman here:
on the assumption that future growth rates match what we've observed over the past two
decades and indeed over most of the past century, an expected long-term total return of 10% for
the S&P 500 would currently be consistent with an index level of 672. Again, the above result
doesn't mean that stocks must actually drop to 672. It just means that at current levels, the
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 6/23
prospective long-term return on stocks is nowhere near 10% annually. It also means that if
stocks are eventually priced to deliver a long-term return of 10%, say, a decade from now, the
total return on the S&P 500 between now and then would average roughly [ 1.10 *
(672/1106)^(1/10) – 1 = ] 4.65% annually. “
This puts a strong emphasis on market valuation as the dominant factor into determining a
proper market climate (together with market action) and also stresses the robustness of that
appraisal by underlying that - quote again: “So one can choose from a variety of historically
credible and long-term reliable valuation methods cyclically adjusted earnings, nominal
dividends, real dividends, q ratio, and so on – and one obtains largely the same result.”
4) Using HSGFX's historical performance data
(, briefly discuss the components of the
Fund's returns. What risk and return characteristics has the Fund's hedging approach
added to the overall risk and return. What risk and return characteristics has the stock
selection strategy added to the overall risk and return?
To discuss the components of the Fund’s returns I will comment a chart derived from the
HSGFX’s performance data and published in the Hussman semi annual report dated December
31, 2011. Comparison of the Change in Value of a $10,000 Investment in Hussman Strategic
Growth Fund Versus the Standard & Poor’s 500 Index and the Russell 2000 Index (from
Hussman 2012)
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 7/23
By separating the raw performance component of the fund referred to as HSGFX equity
investments and cash equivalents (un hedged)” from the global performance of HSGFX itself
and by displaying two reference indexes on the same chart, namely the S&P500 and
Russell2000 the above chart is a perfect tool to support the discussion over more than an entire
The first observation is that the stock selection strategy has a not only a favourable risk and
return profile as compared to the indexes, but remarkably so. Raw HSGFX has grown at a faster
pace than the reference indexes, 108.5% more than S&P500 and 32.45% more than the
Russell2000 for volatility much comparable to that of the Russell 2000 and not presenting
bigger drawdown in % than the indexes. Therefore, the stock selection process can be
considered as the major source of return, rightfully so as it focuses on selecting strong securities
with excellent cash flow records and strong business perspectives and margins.
The Fund’s hedging approach has considerably reduced the drawdown demonstrated by raw
HSGFX at the expense of just slightly reducing the final performance which remains stellar over
the period as compared to the reference indexes for a tiny fraction of their volatility and
drawdown (i.e. the deepest loss experienced by the Fund since inception was -21.45%,
compared with a maximum loss of -55.25% for the S&P 500 Index). HSGFX has grown 23%
more than the Russell 2000 and 93.5% more than the S&P500 over the same period with a
fraction of the volatility and drawdown. This is undoubtedly a great performance which is
corroborated by the personal commitment of the own money of the manager himself who has
invested most of his assets in the Fund and demonstrates by doing so that he does not see better
vehicle than HSGFX to maximize his own returns.
5) How did we adapt our analytical methods in response to the 2008 2009 credit crisis?
What provoked this research and what was its outcome?
Most of the answer to this question has been written in various places by J. Hussman himself, so
I’m not going to paraphrase this material with little talent by awkwardly repeating or distorting
what was well written and explained in several places. Therefore, I will articulate a series of
quotes that will demonstrate how things happened and how the manager brought solutions to
what appeared to be a puzzling challenge. As a side note I will add that having gone myself
through this market, I could share the concerns of J. Hussman over the possible outcomes lying
far out of the samples used and heard myself the whistle of the bullets that all markets
participants felt at that time!
The first problem stressed by J. Hussman and described in the Dec 2011 annual report is that the
hedging models used performed well on data sets benchmarked since 1950 but in fact would
have led to locally unbearable losses (i.e. more than 40% - wmc120206) if the Fund had
increased its participation when implied returns grew to 10% (i.e. S&P500=760) would the
market imitate the great depression era and still lose two thirds of its value from this point.
Quote from annual report:
“In response to the 2008-2009 crisis, I believed that it was the responsibility of portfolio
managers to stress-test each aspect of their investment approach, though I am still not
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 8/23
convinced that much of Wall Street has stress-tested anything at all. For us, stress-testing meant
taking our models to Depression-era data, because it was clear that events of the time were
largely “out of sample” from the standpoint of post-war data. At the time, we were basing our
estimates of market risk and return on data since about 1950, which I had expected was
sufficient to capture “modern” market behaviour. Prior to 2008, it seemed unlikely that the
U.S. would face Depression-like credit strains again. While our existing hedging approach
performed well in Depression-era data overall, the occasional losses were far deeper than I
was willing to risk for our shareholders. The result was what I called a “two-data sets”
problem, which demanded that our hedging methods perform well, out-of-sample, and with
tolerable risk, in data drawn from both post-war and Depression-era periods. We reached a
satisfactory solution in late 2010 with the introduction of our ensemble approach.”
Therefore, a two data set problem appeared depending on whether data prior to 1950 and back
to the great depression era were included in the benchmarking process. In wmc110822, the
manager states that “After struggling with that "two data sets" problem through 2009, we finally
reached a satisfactory solution in 2010 using an ensemble approach, which we implemented
late in the year”.
Finally the ensemble approach is described again in the annual report. Quote from annual
“One of the main approaches we use to estimate return and risk prospects is to group current
market conditions among historical instances that are most similar. Each point in history is
defined by various “features” based on a broad range of key factors, including valuations,
measures of market action, investor sentiment, economic factors, and so forth. In order to make
the analysis less dependent on any particular historical period (e.g., post-war data, bubble-era
data, Depression-era data), or any single set of indicators, we extend this analysis to a very
large number of randomly selected sub-samples across history. This sort of analysis is an
example of an “ensemble method” of modelling which has several benefits, the two most
important being on measures of “accuracy” and “robustness.”
For additional information one can also read “A tale of two data sets in wmc090831.htm,
“Looking back, looking forward” in wmc100426.htm and “Setup and resolution” in
And to better understand J. Hussman’s analysis of the situation at the market bottom of March
2009, which I wholeheartedly shared at the time I will suggest reading this small excerpt from
Moreover, from a valuation standpoint, a further market trough would not even be "out of
sample" in post-war data. Based on our standard valuation methods, the S&P 500 Index would
have to drop to about 500 to match historical post-war points of secular undervaluation, such
as June 1950, September 1974, and July 1982. We do not have to contemplate outcomes such as
April 1932 (when the S&P 500 dropped to just 2.8 times its pre-Depression earnings peak) to
allow for the possibility of further market difficulty in the coming years. Even strictly post-war
data is sufficient to establish that the lows we observed in March 2009 did not represent
anything close to generational undervaluation. We face real, structural economic problems that
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 9/23
will not go away easily, and it is important to avoid the delusion that the average valuations
typical of the recent bubble period represent sustainable norms.”
By the way, S&P500=500 is also a level mentioned many times by Albert Edwards, an analyst
and expert I pay a lot attention to as I will indicate in section 12.
In “setup and resolution” wmc110103, a summary of the way the analytical methods have been
adapted to the last credit crisis is summarized in the following excerpt:
The basic approach falls into the class of what are called "ensemble methods." Our investment
positions continue to be driven by our most reliable measures of valuation, market action,
sentiment, yield pressures and other variables, but rather than applying a single model over the
full span of history, we can use multiple models and evaluate them over numerous samples of
history. In that way, we can measure not only risk (the spread between individual returns and
the average outcome), but also uncertainty (the possibility that any particular model or view
about the world is incorrect).
Some final thoughts by J. Hussman in wmc111219
“It's worth repeating that our "stall" in 2009 and early 2010 was based on my insistence that
our methods should perform strongly in Depression-era data and other periods of credit crisis
outside of our traditional post-war U.S. dataset. Admittedly, the resulting ensemble models
would, in hindsight, have been much more constructive than we were in practice during that
period, but I insisted that we should "First, do no harm" until I felt confident that our methods
could navigate arbitrarily extended periods of credit crisis and economic turmoil. I'm convinced
that those efforts will prove their necessity in the years ahead. In any event, we now have far
less concern over the prospect of the economy throwing something entirely "out of sample" at
us. My suspicion is that analysts whose understanding of the investment markets is based solely
on experience since the 1990's have absolutely no idea how far outside of that sample most of
history lives.”
6) Briefly explain the concept of duration and discuss the management of bond duration in
the Strategic Total Return Fund.
The price of a fixed-income security reflects the present discounted value of future interest and
principal payments. The duration is the average date at which these payments are made
weighted by their present value and gives the change in the value of a fixed income security that
will result from a 1% change in interest rates. Duration is stated in years. For example, a 5 year
duration means the bond will decrease in value by 5% if interest rates rise 1% and increase in
value by 5% if interest rates fall 1%. Duration is a weighted measure of the length of time the
bond will pay out. Unlike maturity, duration takes into account interest payments that occur
throughout the course of holding the bond. Basically, duration is a weighted average of the
maturity of all the income streams from a bond or portfolio of bonds. So, for a two-year bond
with 4 coupon payments every six months of $50 and a $1000 face value, duration (in years) is
0.5(50/1200) + 1(50/1200)+ 1.5(50/1200)+ 2(50/1200) + 2(1000/1200) = 1.875 years. Notice
that the duration on any bond that pays coupons will be less than the maturity because there is
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 10/23
some amount of the payments that are going to come before the maturity date. In this example,
the maturity was 2 years. Investors use duration to measure the volatility of the bond.
The duration refers to the interest sensitivity of a fixed-income security (or portfolio of), mainly
related to the average date at which an investor receives payment of principal and interest. In
simple terms, the longer the maturity of the bond the more sensitive it is to interest rates
The Strategic Total Return Fund shows durations ranging between 1 year and 15 years.
Therefore, in its more aggressive stance, the Fund’s NAV could fluctuate up to 15% in response
to a 1% variation of the general level of the interest rates.
The Fund's principal investment strategies emphasize strategic management of the duration of
portfolio holdings, the Fund's exposure to changes in the yield curve and allocation among
fixed-income alternatives and inflation hedges.
Strategies used to increase interest rate exposure include the purchase of long-term bonds
thereby increasing the maturity and average duration of the Fund and / or Treasury zero-coupon
bonds or Treasury interest strips which are highly sensitive to rate changes.
Strategies to decrease interest rate include reducing the average duration of the Fund or hedging
the risk by the purchase of put options and writing of call options on Treasuries. It is worth
noting that the total notional value of such hedges (i.e. the dollar value of Treasuries represented
by these options combinations held by the Fund) will not exceed the total value of the bonds
held by the Fund with a remaining maturity of 5 years or more. In case where it equals, the Fund
will be considered fully hedged.
The two most important dimensions of the strategy consider "valuation" and market action,
whereby favourable valuation means that yields on long-term bonds appear reasonable in
relation to inflation, to short-term rates, economic growth and yields available on competing
assets (e.g. utilities, foreign bonds, etc.). Moreover, diversification in precious metals stocks of
foreign bonds are favoured when real US rates (i.e. nominal minus inflation) are declining
relative to real foreign interest rates (goes along with a weakening USD).
As a summary the duration of the Fund is adjusted in response to market conditions. The
manager limits the risk of capital loss by shortening portfolio duration during historically
unfavourable market conditions and increases the Fund’s potential capital gains by lengthening
portfolio duration during decreasing rate environments.
7) What are the primary market and economic factors that influence the value of a foreign
currency? Explain why these characteristics help to determine the level of exchange rates.
To address this question, I would refer to a couple of excellent papers published as weekly
market comments or research notes by J.P. Hussman. The first is “How exchange rates are
determined - a primer” on 23rd of August 2010 and the second is “Valuing Foreign Currencies”
a note first published on 22nd of Sept 2000. The Purchasing Power Parity (PPP) is a long term
means to address exchange rates and factors in respective or differential inflation rates that
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 11/23
would be met in the corresponding countries and the Interest Rate Parity (IRP) is a short term
fluctuation factor that drives currency movements searching for better monetary yield. The latter
paper concluded that the euro at 0,85 was deeply undervalued in 2000 which proved correct as it
moved to a deeply overvalued exchange rate of 1.6 in April and July of 2008.
But we live through extraordinary times and other factors are at work. As indicated in the
aforementioned note quoting Von Misesmassive central bank easing is invariably a form of
cowardice that attempts to avoid the need to restructure debt or correct fiscal deficits, avoiding
wiser but more difficult choices by instead destroying the value of the currency. Therefore on
the very short-term the Euro-USD exchange rate is now more determined by the speed at which
the balance sheet of these two central banks is expanded than anything else. As indicated by
“Tyler Durden” on Zerohedge “The ECB announced last week that its balance sheet was about
to rise by €1 trillion gross, and hit a record €3 trillion net earlier today: the EURUSD barely
budged. Why? Because the key driving relationship for relative performance of the pair is the
correlation of the Fed and the ECB's balance sheets. There exists a clear cross-correlation of the
Fed/ECB total assets and the EURUSD spot, where the first thing that stands out is that the pair
should be 1000 pips lower at least. And yet it isn't. The reason for that is that the FX market is
actively expecting, despite all rhetoric otherwise, an injection from the Fed in the range $650-
700 billion!”.
As a quick answer one would claim that the primary market factor are respective interest rates
offered in the cross FX exchanges and that the principal economic factor is inflation leading to
adjustments of PPP. Having said that, one should notice that expanding the monetary bases as
we observe through QEs and LTROs goes against Monetarism principles as formulated by
Milton Friedman. The excessive expansion of money supply far beyond the legitimate
satisfaction of a bid and ask phenomenon at a given equilibrium interest rate as required or
permitted by the profitability of economic activities is inherently inflationary. Friedman’s k-
percent rule is an attempt to optimize money supply, avoiding both inflation (excess) and
deflation (liquidity crunch).
As a final comment one should note as developed by Hussman in wmc100906 that
“Quantitative easing does not pressure the dollar by fuelling inflation. It has a much more subtle
effect (but one that can be expected to be amplified if fiscal policy is long-run inflationary as it
is at present). Normally, equilibrium in capital flows between countries is achieved through
changes in interest rates. As a result, countries with greater capital needs or higher long-run
inflation tendencies also have higher interest rates. If interest rates can adjust, exchange rates
don't have to. But notice what quantitative easing does: by sitting on long-term bond yields (and
creating a negative real interest rate differential versus other countries), quantitative easing
prevents bond prices from acting as an adjustment factor, and forces the burden of adjustment
on the exchange rate.”
As long as the same rogue policies are followed by all major central banks, equilibrium persists!
"If one does not terminate the expansionist policy in time by a return to balanced budgets, by
abstaining from government borrowing, and by letting the market determine the height of
interest rates, one chooses the German way of 1923."
Ludwig von Mises, The Trade Cycle and Credit Expansion: The Economic Consequences of
Cheap Money (1946).
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 12/23
8) Explain the importance of limiting drawdown in an investment strategy. Provide
The following table is extremely simple and explains very well why limiting drawdown is of the
utmost importance for any decent investment strategy. The table shows a start with a capital of
100$ and considers various loss levels in percentage of the initial capital. The column next to
the Loss gives how much capital gains will be required just to later break even once the loss has
been observed. A loss of 50% of the original capital requires that a remarkable 100% recovery
be made and a loss of 90% requires a subsequent 900% gain just to break even! Whenever the
situation has gone that far, and in fact long before, the recovery is more of a dream than
anything else.
Loss To BE
90 10,00% 11,11%
80 20,00% 25,00%
70 30,00% 42,86%
60 40,00% 66,67%
50 50,00% 100,00%
40 60,00% 150,00%
30 70,00% 233,33%
20 80,00% 400,00%
10 90,00% 900,00%
Table of loss levels in % of original capital and capital gains required to break even (BE).
But how can one lose 90% of his/her original capital? Surprisingly it is not that difficult with at
least two opposite approaches. One is to keep trading long enough with small but regular
consolidated losses (the expectancy of the trading strategy is negative), the other is just to
follow what most retail investors are advised to do as they are not supposed to be successful at
market timing, i.e. buy and hold. Hopefully, simply buying and holding a diversified portfolio is
not the more probable route to bankruptcy, but you cannot rule it out either. For example, in
between the 3rd Sept 1929 (DJIA=381.17) and the 8th Aug 1932 (DJIA=41.2) a buy and hold
strategy would have lost 89.19% (not far from the worse case in the table of 90%) and would
have required to make a whopping 825% come back just to break even. That’s just history and it
can burn those who do not pay attention to it.
Limiting drawdown is one of the more interesting aspects of trading strategies and falls under
the general chapter of risk management. We’ve already mentioned several possibilities to either
limit drawdown by hedging the portfolio or by positioning stop loss orders such that the grand
total of aggregated individual losses would not exceed a maximum arbitrary drawdown or to
measure the value at risk (VaR). Discussing these would go beyond the question asked in this
section and I refer to one of my blogs to illustrate further that matter
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 13/23
9) Discuss the economic concept of "general equilibrium." Compare and contrast
arguments based on general equilibrium versus partial equilibrium.
Léon Walras (1834-1910) is a French economist considered by Joseph Schumpeter as the
greatest of all economists [History of Economic Analysis, 1954, p. 827] who published in 1874
«Principe d’une théorie mathématique de l’échange» in Journal des économistes and “éléments
d’économie politique pure, ou théorie de la richesse sociale”, work that led him to be considered
the father of the general equilibrium theory.
General equilibrium theory is a branch of theoretical economics and seeks to explain the
behaviour of supply, demand, and prices in a whole economy with several or many interacting
markets, by seeking to prove that a set of prices exists that will result in an overall equilibrium,
hence general equilibrium, in contrast to partial equilibrium, which only analyzes single
The problem addressed by Walras is to determine simultaneously the quantities traded and the
prices enabling to balance bid and ask for these quantities. As the ask side of the trade
positively depends on the prices and the bid size (i.e. quantities) negatively depends on the
price, Walras demonstrates that the problem can be set as a system of 2L equations for L goods
traded over L markets, and therefore that as there are as many unknowns as equations, solutions
to this problem may or might exist (but do not necessarily exist!). Walras relied on a process
referred to as “tâtonnement” thanks to a “commissaire priseur”, i.e. the Walrasian auctioneer to
address the existence of equilibrium but could not determine under what conditions such a
process will terminate in equilibrium where demand equates to supply for goods with positive
prices and demand does not exceed supply for goods with a price of zero, nor even prove the
existence of a conclusive such process.
The question of the existence of a solution to this general equilibrium theory will have to wait
until 1954 and the joint contributions of Kenneth Arrow and Gérard Debreu (1921-2004) in
“Existence of an Equilibrium for a Competitive Economy” with an approach based on topology
(“point fixe de Kakutani”) and further developed in “La Théorie de la valuer” published in
1959. The underlying approach of Debreu’s thought is that even though we cannot
mathematically represent the real economy, one can nevertheless assert a formal and logical
representation of what we think an economy is and work with that abstraction, essentially made
for Debreu of sets, i.e. “ensemble”, including a set of goods, of consumers, of consumer
preferences over the goods associated to the consumers, of production technologies of the set of
goods, etc. He develops an axiomatic analysis of the notion of general equilibrium base on set
theory (i.e. Nicolas Bourbaki’s “Théorie des ensembles”) from which are derived three classical
major interpretations: a spatial model representing international trade, an inter temporal
equilibrium representing forward markets for all goods at all dates, and a “principe
d’incertitude” addressing conditional transfer or delivery of goods based on the occurrence of
particular events in Chapter 7 of "New Concepts and Techniques for Equilibrium Analysis",
1962, International Economic Review published while he works at Stanford.
In partial equilibrium analysis, the determination of the price of a good is simplified by just
looking at the price of one good and assuming that the prices of all other goods remain constant.
The Marshallian theory of supply and demand is an example of partial equilibrium analysis.
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 14/23
Partial equilibrium analysis is adequate when the first-order effects of a shift in the demand
curve do not shift the supply curve. Partial equilibrium analysis is of little help and does not
apply when an increase in price on a given product or commodity (e.g. oil market) has vast
consequences on a set of intertwined and dependent economic variables and products moving a
large number of dependent and correlated goods.
Market makers operating on the floor to ensure liquidity on both bid and ask side tend in a sense
to act as Walrasian auctioneers discovering prices in a partial equilibrium process, limited to one
security. Of course, as that function is being held today mainly by computerized programmes
they tend to embody the Walrasian operator but offer additional sophisticated behaviours that
may lead to surprising situations. Whenever such a computer programme gets out of the range
of its safe confidence arbitrage technique underlying the liquidity offering, (e.g. exceptional
volatility) it may suddenly withdraw from the book and lead too confident traders on their own
with little or no reasonable bid / ask sides. Whatever the explanations provided for the 6th May
2010 flash-crash may have been, this phenomenon must have played a role on some securities at
least as retail traders had market orders that were filled at insane prices due to the withdrawal of
the automated “Walrasian auctioneers” leaving them naked. As an example, I will give RIT
(LMP real estate) which experienced a 72% intraday drop to close just at a 11% discount (i.e.
OHLC: 9,48 – 9,49 – 2,64 – 8,45). The partial equilibrium process of price discovery had let the
place to total unbalances. What still puzzles me is that transactions were not halted and were in
the end executed!
10) Using NBER recession dates and Robert Shiller's S&P price data, discuss the
performance of the stock market around recessions. Describe how the onset of market
weakness and the subsequent market recovery typically relate to the beginning and
duration of a standard recession.
This topic is well discussed in two papers published by William Hester, one is entitled “Stock
Performance Following the Recognition of Recession” in Nov 2008 “recessrecog.htm” and the
second is entitled “Market Valuations During U.S. Recessions” in March 2009
The first paper addresses the question of how does the market perform from the point that the
majority of investors recognize that the economy is in recession and uses NBER dates from the
Business Cycle Dating Committee as these are widely accepted as references.
The first point made by the author and summarized in the following chart is that:
“Since 1980, market returns have been mixed following the BCDC recession declaration dates.
Despite a declared recession, stocks were typically unchanged 3 months later. In three
instances (1980, 1982, and 1991), stocks were 10-20% higher after a year, but in the 2001
instance, stocks were down about 20% a year later. Two years after the declaration, stocks
tended to be moderately higher, but usually after a lot of sideways movement.”
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 15/23
Basically the most influential factor to the market performance following the announcement of a
recession by the NBER is the previous valuation level displayed by that market. This is what
explains the dismal performance of the market following the dating of the 2001 recession, when
the market fell another 33 percent before eventually bottoming in 2002.
To broaden the scope of the study in order to include older recessions, Hester uses two other
methods to date the entrance of a recession, i.e. one is based on economists' forecasts such as the
Survey of Professional Forecasters dubbed the “Anxious Index” the other is interesting as
absolutely objective, relying on technical analysis, and proposed by Ned Davis who computes
the 44-day moving average of the percent difference between the market's daily high and low
price reflecting like the VIX the changes in volatility.
From these three methods, Hester concludes that:
“Overall, market returns following the broad acceptance of recession using the three methods
above have been mixed, with a bias toward gains except when valuations were still high when
the recession was recognized. Despite a recognized, ongoing recession, short-term returns were
fairly flat, though with above average volatility. Returns over a longer-term period tended to be
stronger. Over our three indicators, average 12-month returns were 9 percent. Over 2-year
periods returns averaged 18 percent.”
But the major point of Hester’s paper is that the vast majority of the losses during a recession-
induced bear market are made long before that the official recession be acknowledged, special
case being observed when a continuation of the losses happens due to extremely high initial
market valuations at the beginning of the downturn.
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 16/23
This chart is borrowed from the same paper and shows the S&P's return from the beginning of
each recession-induced bear market up to the point of acceptance, using the Anxious Index as
the indicator.
One can observe from the chart that the first 150 days of the downturn show limited damage to
stocks and sometimes display significant technical pullback and that the bulk of the losses is
made from the point where the majority of investors recognize that a recession is happening, in
fact nearly a year or so before the official recession date is acknowledged and announced. But as
Hester underlines;
“But once a recession has been recognized, and valuations become reasonable, the prospects
for longer term returns typically improve.”
The second paper addresses the issue of determining means to assess what are typical valuation
levels during recessions and show their statistical distributions. To that aim NBER dates are
used, and earnings are normalized by resorting to Robert Shiller's P/E ratio, which is based on
the trailing 10-year average of real earnings. Hester’s objective was clearly stated as trying to
figure out in March 2009 how much of a bargain the market was at the time when put in a much
broader perspective, encompassing both “normal periods” referred to as “full period” since 1950
and more specifically during recessions.
The histograms displayed hereafter are borrowed from this paper for the sole purpose to answer
these pre-interview questions as no permission was requested nor granted observing that rights
are reserved and fully enforced by the author who is a member of the Hussman team.
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 17/23
Dismissing outliers in each data set appearing mostly as a result of the late 1990's bubble and
high valuations at the end of the 2001 recession, the bulk of the market's valuation multiples on
smoothed (10-year) earnings during recessions sit between 7 and 25 whereas the price to
smoothed earnings ratio for the full data set (1950-2009) has been about 19.
Therefore, to specifically address the question raised here, i.e. how does the market perform
around a recession, the bottom histogram shows clearly that the distribution of valuations during
recessions is tighter and is shifted toward lower levels. The average multiple during recessions
has been about 14.5, but the histogram is slightly skewed and the mean being distorted to
around 12.
The paper later focuses more of the specific valuation of the market observed in March 2009
and goes beyond the scope of this question, but an interesting point was made in questioning
whether profits even normalized were representative given the exceptional profit margins
observed. It was therefore stated that:
“One way to sidestep the distorted message of normalized earnings is to move up the income
statement. In particular, we can move all the way to the top, and look at the market's price to
sales ratio (which is unaffected by profit margins).”
Furthermore, it is suggested to use a proxy to this P/S ratio (only goes back to 1950) in order to
cover a much larger timescale, which is the ratio of market capitalization to GDP have tracked
each other well over time. The histograms below show the market capitalization to nominal
GDP ratio since 1924.
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 18/23
In his paper, Hester focuses on where the March 2009 market stands with respect to a full period
which spans from 1924 to 2009 and blue bars in the histogram correspond in that case to the
March 2009 low. He rightfully concludes that March 2009 low valuations were not particularly
attractive based on these histograms:
“And from this perspective you can see that the bulk of periods where the economy was in
recession, stock market capitalization has been lower relative to GDP than at present. Current
valuations are at the 60th percentile for the full period. For the recession subset, current
valuations are at the 70th percentile, meaning more than two-thirds of the time when the US
economy was in recession, the market capitalization as a percent of GDP was lower than it is
But from the standpoint of the question we address, I will notice though that once the
assumption that the wide-spread use of leverage and the above-average profitability of financial
firms lead to still overstate the earnings power for a broad range of stocks, and therefore the
S&P 500, the corrected ratio given by the market cap as a percentage of GDP does not
demonstrate so convincingly as before the case that valuations stand lower during recession
It is still correct to observe that there are less outliers during recession than normal periods, that
the distribution is more “Gaussian” and more condensed, but the average would fall somewhere
around 45 instead of 50 which is just a slight deviation towards lower Market cap / GDP ratio.
As a summary one can conclude that most of the damage to the market is made long before
official recession date are set by the NBER committee, that the worst period covers the year
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 19/23
before the date set for the official recognition of the recession and that outcomes are from that
point mainly favourable, though with much increased volatility, except where valuations were
extreme before the recession-induced bear market began.
11) Calculate the average returns for the S&P 500 (from 1 10 years, for example) following
various levels of cyclically adjusted PE ratios (by quintile, for example). Explain the
importance of the level of valuations for investors with varying time frames. Use a chart or
graph if appropriate.
The first observation is that there is an equivalence between cyclically-adjusted PE ratios (i.e.
future PE / current PE) and S&P500 market levels. As discussed by Hussman in various places
and in agreement with Jeremy Grantham, the estimate of the fair S&P500 value currently stands
at 920, As it seems important to centre the presentation around that reference level we will use
hereafter quartile instead as quintile (as they were suggested but not imposed) in that it enables
to have a PE ratio equivalent to the middle of the range we consider and corresponding to a key
market level of 920. Further to that, we will take the lowest PE ratio to consider in this short
study as corresponding to the SP level of August 1950, and make an equal spacing (quartiles)
along a log scale that will deliver an equal distance (i.e. 0,1855) between PE ratios and their
equivalent market levels. This delivers the following S&P levels: 391, 600, 920, 1410, 2160
series where log(2160-1410)=log(1410-920) etc. = 0,1855 therefore ensuring four equally
spaced segments (quartile).
It is now very easy and straightforward to compute expected average returns for each of these
various levels of adjusted PE ratios using the classical formulae over a time horizon T:
Total return = (1+g)(future PE / current PE)^(1/T) - 1
+ dividend yield(current PE / future PE + 1) / 2
To keep thing simple, the second term, i.e. average dividend yield over the holding period, will
be taken as 2% and the term “g” will be taken as 6,3% though we referred in section 2 to a
better way to compute g.
Therefore the implied total return for a period of 1 to 10 years gives the following table (with
corresponding PEs computed on the basis that the proper historical norm for price-to-forward
operating earnings is approximately 12.7):
500 PE
Years 1 Year
2161 29,8
0,68% -1,60% -2,73% -4,17% -6,06% -8,64% -12,38% -18,26% -28,84% -52,87%
1410 19,5 3,57% 3,09% 2,49% 1,73% 0,72% -0,68% -2,73% -6,06% -12,38% -28,84%
920 12,7 8,00% 8,00% 8,00% 8,00% 8,00% 8,00% 8,00% 8,00% 8,00% 8,00%
600 8,3
% 15,83% 17,46% 19,95% 24,23% 33,26% 64,53%
391 5,4
% 24,25% 27,78% 33,28% 42,99% 64,60% 151,41%
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 20/23
The line in the middle of the table gives for a PE of 12.7 and an S&P500 market level of 920 the
expected implied total returns over 10 to 1 year. As this is the reference level, whatever the time
horizon, one can expect from that level an average annual 8% total return. This corresponds to
current S&P500 profits of 72.44, but in fact this 8% return can also be obtained and confirmed
by simply inverting the classical compounding interest formulae. This gives the observed return
for a given increase in capital (measured as a ratio) over T years:
Ratio can be a market ratio over a time span, e.g. S&P500=16.66 on Jan 1950, lowest quartile at
391 in our table gives a ratio of (391/16,66)=23,47 over 62 years, i.e. a return of 5,23% plus the
dividends (part of supposed reinvested). Those are observed returns for given reference market
Over a 10 years horizon (first column), one can easily see that at 1410 (PE=19,5) the expected
return falls to 3,57% and even gets negative (i.e. -0,68% annually) at 2161 (over an entire
decade !) which roughly corresponds to PEs reached at the top of the 2000 bubble. Lowering
PEs, at S&P500=600 (PE=8.3) one can expect an average yearly return of 12.63% over the
period and at S&P=391 the annual implied return grows to 17.47%.
Now, one can easily appreciate the importance of the time horizon by moving to the right of the
table to shorter time frames as it exacerbates the implied returns of a given level of valuation of
the market. Another way to look at the table is to consider the minimum time scale to remain
invested from a given PE level to get an expected positive return. By doing so, one can learn
that at SP=2161 even over an entire decade of patience the expected return will still be negative
and that at SP=1410 (i.e. not far from where we stand at 1371 on 120309) the minimum
investment period to get an implied positive return will be 6 years (i.e. 0.72% which will
certainly not be a break even once inflation is factored in).
Therefore, one can easily understand from the previous table that the shorter the time scale
during which the investor plans to remain in the market, the more dangerous it is to forget
market valuations consciousness.
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 21/23
Im pl ie d tota l re turn over Y years for m a rke t & PE Qu artiles
10 Years9 Yea rs8 Yea rs7 Yea rs6 Yea rs5 Years4 Years3 Years2 Years1 Yea r
21 61
14 10
92 0
60 0
39 1
The chart shows for the quartiles chosen and the five corresponding market or PE levels
considered how dangerous it can be to shorten the investment horizon while at the same time
neglecting valuations. Convergence on the right delivers the expected implied return over a
Not paying proper attention to market valuation will lead in any case to dismal results even over
an entire decade, as was the case for market participants in the great 2000 bubble (i.e. our
example case with the higher 2161 quartile at PE=29,8 delivers -0.68% annually over 10 years).
12) What source of financial market research, journalist, or organization do you find
yourself agreeing with most frequently (excluding research from Hussman Funds)?
Discuss why.
To the risk of answering not exactly to the point, I do not look for papers or analysis on the
basis that I would solely agree or not with the material they contain. Of course, in the end, I tend
at least to share grounds in my understanding of the grand picture with most of the authors I
read, but the most important point is how well developed and substantiated the arguments made
In that respect, beyond Hussman’s weekly market comment which I must be one of the first
readers on European time early Monday, I enjoy going through a large range of data and
information sources. I either return regularly to their web sites or “google” for specific names
and authors to keep up with the news as they develop and as they analyse them.
Among a few names I’ll toss here are Jeremy Grantham (GMO), John Maulding, James Montier
and Albert Edwards, Tyler Durden (pseudo) of Zero Hedge, but I also go across many web sites
such as the,, got inspired by the turtles and
technically by Stan Weinstein, listen to some French authors as Marc Fiorentino, Olivier
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 22/23
Delamarche, Olivier Crottaz (Swiss) and read specialized webzine
media like,,, I also consider many broad and diversified information sources
such as,,, etc.
In the end, my profile as an investor has changed over the years. Moving away from trading,
being much more value conscious but still paying attention to market action with a set of
proprietary but simple Metastock indicators and tools which I use to identify with a reasonably
high reliability Bull / Bear cycles.
Cogley, Timothy and Sargent, Thomas J. , 2009. Diverse Beliefs, Survival, and the Market
Price of Risk, The Economic Journal, Volume 119, Issue 536, p. 354–376.
Hussman, John P., 1992. Market efficiency and inefficiency in rational expectations equilibria:
Dynamic effects of heterogeneous information and noise, Journal of Economic Dynamics
and Control, Volume 16, Issues 3–4, July–October 1992, p. 655–680.
Hussman, John P., 1993. A Note on the Interpretation of Cross-Sectional Evidence Against the
Beta-Expected Return Relationship, University of Michigan, June 1993, 5 pp.
Hussman, John P., 1998. Time-variation in market efficiency: a mixture-of-distributions
approach, 1998, Hussman Strategic Advisors, Inc., 16 pp.
Poyet, Patrice, 2005. Systèmes Experts de Trading en Ligne - Trading Expert Systems On Line
TExSOL. DOI: 10.13140/2.1.1212.4809 Report number: Version Mars 2005 - 194 pp.
Sharp, William F., 1964, Capital asset prices: a theory of market equilibrium under conditions
of risk, Journal of Finance 19, 425-442
Twelve answers to John P. Hussman's Financial QUIZZ by Patrice Poyet, March 2012. p 23/23
ResearchGate has not been able to resolve any citations for this publication.
Technical Report
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GB: This document in French describes the trading expert system developed by Patrice Poyet and Guillaume Besse to manage long / short portfolios including techniques for stock selection, risk management and global portfolio monitoring. FR: L'objet de ce document est de permettre aux utilisateurs de notre système expert boursier en ligne TexSOL®, de disposer des notions de base qui leur garantiront de faire le meilleur usage des exceptionnelles fonctionnalités offertes par le système. Compte tenu du caractère très hétérogène de la population des utilisateurs d'un tel logiciel, nous avons décomposé cet ouvrage en deux parties: la première est une introduction à tous les concepts boursiers ou liés aux marchés, utiles car exploités d'une manière ou d'une autre par TExSOL®, la deuxième est une présentation ciblée sur les fonctionnalités réellement implémentées à ce jour par le logiciel, c'est à dire les différentes stratégies offertes, les mécanismes auxquels elles recourent, les portefeuilles correspondants et courbes de gestion des risques, et de la couverture à mettre en œuvre pour tenir ces positions. En matière de systèmes experts, il n'a pas été jugé utile de rentrer dans le détail de leur conception ou de leur implémentation informatique, les auteurs de ces systèmes ayant une expérience de plus d'une quinzaine d'année en la matière, ils renvoient à la liste des références bibliographiques correspondante pour les lecteurs intéressés par cet aspect. Pour ce qui concerne les notions liées aux marchés et à la finance en général, nous vous proposons un glossaire assez complet, et nous avons souvent indiqué les termes anglais correspondants, pour lever toute ambiguïté et vous faciliter vos lectures ultérieures.
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Abstract Market efficiency implies a positive relationship between market risk and expected return. Using ex-ante conditioning variables implied by the definition of total return, the time series of U.S. stock market data is partitioned into a set ,of conditional ,distributions. These distributions suggest that market risk is not universally efficient, but displays varying degrees of efficiency in generating expected return. The conditional distributions also exhibit differences in the expected mix of positive and negative outlier returns, Sharpe ratios, maximal investment loss, and business cycle characteristics. A broader definition of efficiency compatible with these results is discussed.
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Recent empirical evidence suggests the absence of any significant relation between average stock returns and market βs, contrary to the Capital Asset Pricing Model of Sharpe (1964), Lintner (1965) and Black (1972). Employing the cross-sectional regression
A great many people provided comments on early versions of this paper which led to major improvements in the exposition. In addition to the referees, who were most helpful, the author wishes to express his appreciation to Dr. Harry Markowitz of the RAND Corporation, Professor Jack Hirshleifer of the University of California at Los Angeles, and to Professors Yoram Barzel, George Brabb, Bruce Johnson, Walter Oi and R. Haney Scott of the University of Washington.
We study prices and allocations in a complete-markets, pure-exchange economy in which there are two types of agents with different priors over infinite sequences of the aggregate endowment. Aggregate consumption growth evolves exogenously according to a two-state Markov process. The economy has two types of agents, one that learns about transition probabilities and another that knows them. We examine allocations, the market price of risk and the rate at which asset prices converge to values that would be computed under the assumption that all agents know the transition probabilities. Copyright © The Author(s). Journal compilation © Royal Economic Society 2009.
The paper examines time series properties and efficiency of a securities market where disparately informed traders hold rational expectations and extract signals from the endogenous market price. Two equilibria are calculated, using a method of Sargent to handle the problem of infinite regress. When rational speculation is the sole source of potential trade, the market price reflects all private information, and zero trade occurs. When net supply is perturbed by unobserved noise, the market exhibits a broad range of characteristics cited in empirical literature, including excess volatility, mean reversion, dividend yield effects, trading volume, and divergence of opinion.