Monday, October 13, 2008

Some Prudent Advice from Dr John Hussman

Here are some important pointers from one of my favorite contrarians, the well-respected Dr. John Hussman on today’s market. BTW, Dr. John Hussman has been widely known as one the “perma bear” in the investment community. Excerpts From “Four Magic Words: "We Are Providing Capital"…

(all highlights mine)

1. ``Look, a few weeks ago, there was a $700 billion pile of money on the table, but the only way for Wall Street and bureaucrats to get their paws on it was to scare the public out of its collective gourd. They succeeded, but created the psychology that the U.S. was on the verge of depression if the bailout wasn't passed. Having created that psychology, the crisis took on a life of its own.”

Our Comment/Interpretation: The Power of suggestion took its own life; government engendered or prompted this panic!

2. ``Word to the wise - don't accept advice or analysis about this crisis from anyone who failed to anticipate it in the first place! The people warning about Depression now are the same reckless jackasses who told investors that stocks were cheap and resilient at the highs.

Our Comment/Interpretation: To Preach Doom Has NOW become MAINSTREAM! Halloween costumes are a fad. Beware of these false prophets.

3. ``Stocks are now measurably undervalued…Stocks are now at the same valuations that existed at the 1990 bear market low.”

Our Comment/Interpretation: From the valuation viewpoint, today’s market is a BUY.

4. ``The problem in the U.S. financial system amounts to roughly 5% of the mortgage assets outstanding. Virtually all of this panic can be traced to the wipeout of shareholder equity in highly leveraged institutions, but it's only a small percentage of the volume of loans in the financial system. Investors are now being quoted ridiculous dollar figures in the trillions and quadrillions (e.g. the total value of the U.S. housing stock, or the un-netted notional value of financial derivatives) as if these figures represent potential losses. The people spouting these figures are appealing to the worst impulses of a frightened public that doesn't fully understand the market mechanisms at work here.

Our Comment/Interpretation: Problems in the US economy should be seen in the right perspective. It’s easy to sell fear.

5. ``The proper way to address homeowner distress is not for the government to buy troubled mortgages and simply reduce the principal. That idea is utterly insane. If that policy was enacted, every homeowner in America would have an incentive to immediately go delinquent on their mortgage. Rather, Congress should provide for a relatively modest alteration in bankruptcy laws, allowing judges to write down mortgage principal but at the same time provide the mortgage lender with what I'd call a “Property Appreciation Right” (PAR) that would give the lender a claim on some amount of future price appreciation of property owned by the borrower. In that way, the mortgage lender would have the prospect of being made whole over time, homeowners who have faithfully made payments on their own mortgages would not be discriminated against, and homeowners in trouble would surrender some future price appreciation for immediate reduction in their monthly payment burden.

Our Comment/Interpretation: TARF is a bad idea. Infuse capital instead.

6. I recognize that all of this is very scary, particularly the rate at which the market has declined, which seems unprecedented. But it is important for investors to understand that the current selloff has all the quite standard markings of a “panic, of the type that Charles Kindleberger described in Manias, Panics, and Crashes: a “seizure of credit in the system.” It is just mind-boggling to hear financial reporters and Wall Street “professionals” foaming at the mouth that the difficulties we are observing today are wholly new and unprecedented. We've seen these before.

``Economist Stephen Roach wrote weeks ago that “ The most important thing about financial panics is that they are all temporary. They either die of exhaustion or are overwhelmed by the heavy artillery of government policies. That fact is worth remembering here.

Our Comment/Interpretation: Market panic has been PART of the cycle! See below…

7. ``In contrast, if your asset allocation is consistent with your risk tolerance, you're diversified, and you have a “full cycle” investment horizon, stick with your discipline. If your exposure to risk is small, a panic is a good time to increase it gradually on depressed prices. That is what good investors do. The bad investors are the ones that establish leverage at tops and are forced to sell at bottoms. Those investors unfortunately exist, and their behavior can amplify movements in both directions, but a disciplined, gradual, diversified strategy should allow for that.

Our Comment/Interpretation: Good Investors buy on Panic, Bad investors buy the fad. Always maintain discipline!

8. ``In a market economy, profits are the compensation that people earn for providing scarce resources. One of the scarcest resources here and now is the willingness to accept risk, the willingness to put a bid out at a low price so that someone can actually sell. You don't exhaust your whole risk budget, or even the majority of it, but you move gradually, in steps, the scarier and more volatile the market, the smaller the size of the trades and the bigger the discounts you require. In short, a good investor provides scarce resources, liquidity, risk bearing and (if you're a good investment analyst) information, when those resources are in furious demand.

Our Comment/Interpretation: It is the time to take risk, and be promptly paid for it.

Thank you, Dr. Hussman.


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