Hussman Weekly Market Comment: Aligning Market Exposure With the Expected Return/Risk Profile

Some risks and market conditions are more rewarding than others. My objectives for this week’s comment are very specific. First, to demonstrate – using a very simple model – that investment returns do indeed vary systematically with market conditions. Second, to demonstrate that overvalued, overbought, overbullish conditions have historically dominated trend-following measures when they have emerged. Third, to demonstrate the impact of accepting investment exposure in proportion to the return/risk profile (technically the “Sharpe ratio”) that is associated with a given set of market conditions.

My hope is to walk through the general framework of how I think about market exposure. However, what follows is not a description of the investment models we use in practice, which involve more numerous considerations and a much broader ensemble of models and methods. The measures I present here are very simple, and while even these conditions identify strong distinctions between market conditions, they are nowhere close to the degree of separation that can be obtained and validated across history with a broader ensemble of evidence.