A brief case study on why investors should ignore forecasters.
In my book, “Think, Act, and Invest Like Warren Buffett,” I noted that the Oracle of Omaha advised investors: “We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”
I also noted the anomaly, and tragedy, that while investors idolize Buffett, many tend to do exactly the opposite of what he advises—and that applies to acting on the advice of forecasters such as John Hussman.
John Hussman runs the Hussman family of mutual funds. He’s also a former professor of economics and international finance at the University of Michigan, and has a Ph.D. He’s perhaps best known for his persistent criticism of the U.S. Treasury and the Federal Reserve. Since late 2009, he has been calling for another financial crisis due to bad policy choices made by the U.S. government.
Hussman writes a weekly column on his website. He’s highly regarded by many, and often quoted. He clearly is a very smart man who provides thoughtful analysis. With that said, I always advise people to ignore his forecasts because they don’t have any value.
One investor recently asked me to comment on Hussman’s latest musings, which had made him quite nervous. Now, I knew that Hussman had been persistently bearish for quite some time, and I have been asked about his columns fairly frequently. So I went back into my files and dug up what I had written about his comments on the market from Jan. 14, 2013. It provides a great example of why he should be ignored, along with all other forecasters.
From his column: “Present overvalued, overbought, overbullish, rising-yield conditions fall within a tiny percentage of market history that is associated with dismal market outcomes, on average. It’s true that we’ve observed extreme conditions since about March 2012 with little resolution aside from short-term declines. But the S&P 500 remains only a few percent from its March 2012 high, and if history is any guide, the extension of these unfavorable conditions is not likely to reduce the depth of the market loss that can be expected to resolve them.”
Given how well regarded Hussman is by so many, this type of analysis could tempt even disciplined investors to stray from a well-developed plan. Of course, we know now that the S&P 500 Index went on to return 32.4 percent in 2013, and the MSCI Small Cap Index returned 39.1 percent. And both indices have continued moving higher through July 2014, despite continued strong warnings by Hussman.
The Problem With Forecasts
While perhaps counterintuitive, one of the biggest problems with forecasts such as Hussman’s is that many of them present a well-thought-out case and provide insightful analysis, often accompanied by interesting charts; however, as Peter Bernstein noted in “The Portable MBA in Investment”: “The essence of investment theory is that being smart is not a sufficient condition for being rich.”
There is a whole body of literature from academic research demonstrating that there are no good forecasters—not of the stock market, of interest rates, the economy or a whole range of other areas. That’s why I don’t make investment decisions based on market forecasts and neither should you.
As further evidence of why you should ignore market forecasts like Hussman’s, consider the following performance data on his flagship fund, Hussman Strategic Growth (HSGFX). As of Aug. 4, 2014, the fund had $1.1 billion in assets—less than 40 percent of what it had just 19 months earlier—as investors fled, unhappy with the poor performance.
HSGFX is a long/short stock fund. The following is a summary of the fund’s strategy: “The investment seeks to achieve long-term capital appreciation, with added emphasis on the protection of capital during unfavorable market conditions. The fund’s portfolio will typically be fully invested in common stocks favored by the fund’s investment manager, except for modest cash balances that arise due to the day-to-day management of the portfolio. When market conditions are unfavorable in the view of the investment manager, the fund may use options and index futures to reduce its exposure to general market fluctuations. When market conditions are viewed as favorable, the fund may use options to increase its investment exposure to the market.”
Almost sounds like a hedge fund, doesn’t it? And it’s produced returns just like the typical hedge fund.
According to Morningstar, for the 10-year period ending Aug. 1, 2014, the fund managed to lose 1.3 percent a year, trailing the S&P 500 Index—which returned 8.0 percent—by more than 9 percentage points a year. That’s actually even worse than the 10-year calendar returns (2004-2013) of the HFRX Global Hedge Fund Index, which returned 1.1 percent a year. And it’s far worse than the performance of every single major equity asset class over that period.
It even managed to underperform the almost riskless Vanguard Short Term Treasury Fund (VFISX) by more than 4 percent a year for the 10-year period ending Aug. 1, 2014. The fund’s performance placed it in the very last percentile (100) of Morningstar’s rankings for the one-, three-, five- and 10-year periods. And for the privilege of investing with Hussman, investors pay 1.08 percent per year in fund expenses.
The only good news is that it seems the fund’s performance actually forced its managers to lower the fee. When I last looked at it—in January 2013—the fund’s expense ratio was 1.42 percent.
As a side note, Morningstar gives the fund a one-star rating. Why’s that important? A Morningstar study found that just 61 percent of the funds rated at one star in 2004 even survived the next 10 years.
Analyzing the performance of the other Hussman fund with a long track record is more problematic because the fund, the Hussman Strategic Total Return Fund (HSTRX), has the freedom to invest in stocks. The fund had about $2.1 billion in assets in January 2013, but now has just $610 million. You can guess why.
The following is a summary of the fund’s strategy: “The investment seeks to achieve long-term total return from income and capital appreciation. The fund invests primarily in fixed-income securities, such as U.S. Treasury bonds, notes and bills, Treasury inflation-protected securities, U.S. Treasury Strips, U.S. government agency securities (primarily mortgage-backed securities), and investment grade corporate debt rated BBB or higher. Under normal market conditions, the duration of the fund’s portfolio is expected to range between 1 year and 15 years.”
For the 10-year period ending Aug. 1, 2014, the fund returned 5.1 percent. As one comparison, Vanguard’s Intermediate-Term Bond Index Fund (VBIIX), a pure bond fund, outperformed HSTRX, returning 5.7 percent.
It’s hard to make the case that there’s any evidence here of added value based on superior analysis. Again, for the privilege of investing in HSTRX, investors were paying 0.64 percent in expenses, much higher than the cost of Vanguard’s fund (0.20 percent for VBIIX and just 0.10 for the admiral shares version, VBILX).
So, what’s the takeaway? Hussman is a very bright man. He provides compelling analysis and opinions, which I typically find quite interesting. The only problem is that the evidence, including his own track record, demonstrates that investors are best served by ignoring his opinions.
One reason to do so is that he isn’t telling me, or you, anything that other sophisticated investors (such as pension plans, hedge funds and mutual funds) are unaware of. The market has already priced the risks on which Hussman bases his analysis. He just believes he’s smarter than the collective wisdom of the market. Or, at least, he wants you to believe he is, even if he knows better.
If the evidence hasn’t yet convinced you to ignore Hussman’s forecasts, and others like his, ask yourself this question: Do you think you’re better served by following Hussman’s advice or Buffett’s?
The best advice is, instead of worrying about what some guru has to say, to focus your attention on the things you actually can control, such as the amount of risk you’re taking, diversifying those risks as much as possible, keeping costs low and keeping tax efficiency high. That’s playing the winner’s game.
Larry Swedroe is the director of research for the BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.