The Fund seeks to achieve long-term capital appreciation, with added emphasis on the protection of capital during unfavorable market conditions. It pursues this objective by investing primarily in common stocks and using hedging strategies to vary the exposure of the Fund to general market fluctuations.
DATE OF INCEPTION
John P. Hussman, Ph.D.
Hussman Strategic Growth Fund 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 Hussman Strategic Advisors, Inc., the Fund’s investment manager, except for modest cash balances arising in connection with the Fund’s day-to day operations. When market conditions are unfavorable in the view of the investment manager, the Fund may use options and index futures, or effect short sales of exchange traded funds (“ETFs”), to reduce the exposure of the Fund’s stock portfolio to the impact of general market fluctuations. When market conditions are viewed as favorable, the Fund may use options to increase its exposure to the impact of general market fluctuations.
In general, the stock selection approach of the investment manager focuses on securities demonstrating favorable valuations and/or market action. The primary consideration used in assessing a stock’s valuation is the relationship between its current market price and the present value of expected future cash flows per share. Other valuation measures, such as the ratio of the stock price to earnings and stock price to revenue, are also analyzed in relation to expected future growth of cash flows in an attempt to measure underlying value and the potential for long-term returns. The analysis of market action includes measurements of price behavior and trading volume. The investment manager believes that strength in these measures is often a reflection of improving business prospects and the potential for earnings surprises above consensus estimates, which can result in increases in stock prices.
Variable exposure to general market fluctuations
Historically, different combinations of valuation, market action and other factors have been accompanied by significantly different stock market performance in terms of return/risk. The investment manager expects to intentionally “leverage” or increase the stock market exposure of the Fund in environments where the expected return from market risk is believed to be high, and may reduce or “hedge” the exposure of the Fund’s stock portfolio to the impact of general market fluctuations in environments where the expected return from market risk is believed to be unfavorable.
Specific strategies for “leveraging” or increasing stock market exposure may include buying call options on individual stocks or market indices and writing put options on stocks which the Fund seeks to own. The maximum exposure of the Fund to stocks, either directly through purchases of stock or indirectly through option positions, is not expected to exceed 150% of its net assets. This means that the value of the underlying positions represented by options is not expected to exceed 50% of the value of the Fund’s net assets at the time of investment.
Specific strategies for reducing or “hedging” market exposure may include buying put options on individual stocks or stock indices, writing covered call options on stocks which the Fund owns or call options on stock indices, or establishing short futures positions or option combinations (such as simultaneously writing call options and purchasing put options) on one or more stock indices considered by the investment manager to be correlated with the Fund’s portfolio. In addition, the Fund may seek to hedge by effecting short sales of ETFs. The Fund may use these strategies to hedge up to 100% of the value of the stocks that it owns. However, the Fund may experience a loss even when the entire value of its stock portfolio is hedged if the returns of the stocks held by the Fund do not exceed the returns of the securities and financial instruments used to hedge, or if the exercise prices of the Fund’s call and put options differ, so that the combined loss on these options during a market advance exceeds the gain on the underlying stock index.
Because of the Fund’s ability to establish leveraged and hedged investment positions, Fund performance may significantly deviate from that of the major stock indices for substantial portions of the market cycle. When market conditions are favorable in the view of the investment manager, the use of options to increase market exposure may amplify the Fund’s sensitivity to general market fluctuations for meaningful periods of time, and the Fund may experience a net loss of time-value on purchased options. When market conditions are unfavorable in the view of the investment manager, the Fund may experience limited, zero, or possibly negative correlation with general market fluctuations for meaningful periods of time, and the Fund may experience a net loss of time-value on purchased options.
Regular accounts: $1,000
IRA and Gift to Minors accounts: $500
During the period from 2009 to 2017, we faced a significant challenge navigating a speculative market environment. One specific feature of our investment approach was responsible, and it is instructive to understand that how that challenge emerged, and how we addressed it in order to avoid similar difficulties in the future.
Valuations and market internals
We have always believed that investment valuations are the main drivers of long-term returns and full-cycle market outcomes. However, valuations often say very little about market outcomes over periods substantially shorter than 10-12 years. If overvaluation alone was sufficient to halt a market advance, we would never have observed hypervaluation like 1929, 2000, and 2018, because those advances would have ended at lesser extremes.
It is common to imagine that if valuations have pushed to extreme levels without a collapse, there must be something wrong with the valuation measures. But that is not how valuations work. A central fact of full-cycle investing is that when investors have the speculative bit in their teeth, valuations can mean very little for extended segments of the market cycle.
Instead, the main driver of market returns over shorter segments of the market cycle is the psychological inclination of investors toward speculation or risk-aversion. This is typically driven by short-term factors that lead investors to feel optimistic or fearful.
While investor psychology may seem fairly abstract, the best way we have found to measure those attitudes objectively is to examine market behavior itself. When investors are inclined to speculate, they tend to be indiscriminate about it. Conversely, when investors are inclined toward risk-aversion, they tend to become increasingly selective. So we can learn a great deal about investor attitudes from the “uniformity” and “divergence” of market action across thousands of individual securities, sectors, industries, and security-types, including debt securities of varying creditworthiness.
When the market demonstrates divergences and breakdowns in the behavior of various sectors, that loss of “uniformity” is often a signal that investor preferences have subtly shifted toward risk-aversion. That shift is the key feature that distinguishes an overvalued market that moves higher from an overvalued market that drops like a rock. Indeed, the combination of deteriorating market internals in an overvalued market was exactly what allowed us to anticipate the 2000-2002 and 2007-2009 market collapses.
When speculation has no “limits”
What was legitimately “different” about the recent advancing half-cycle? The difference wasn’t about valuations. It wasn’t about market internals. It was about limits.
In previous speculative episodes across history, there was always a point where enough was enough. The emergence of a sufficiently extreme combination of “overvalued, overbought, overbullish” conditions proved to be a reliable warning that speculation had run its course. Speculation had a “limit,” and the market regularly responded with air-pockets, panics, and even crashes.
These “overvalued, overbought, overbullish” warning signs heralded the bull market peaks of 1973, 1987, 2000 and 2007. The methods that came out of our 2009-2010 stress-testing against Depression-era data had prioritized those syndromes, based on their reliability across history. Historically, one could respond to those warning signals pre-emptively, adopting a negative market outlook even before internals had explicitly deteriorated.
Not this time. Amid the novelty of the Federal Reserve’s aggressively experimental policy of “quantitative easing,” investors became convinced that zero interest rates gave them no alternative but to speculate. Stock prices continued to advance long after even the most extreme “overvalued, overbought, overbullish” syndromes emerged. Our defensive response to these warning signs proved to be an Achilles Heel. As prices advanced in the face of increasingly overextended conditions, adopting a negative outlook was not only incorrect, but detrimental.
Adapting our discipline
In late-2017, we abandoned the idea that there is any definable “limit” to the speculative recklessness of Wall Street, as there was in prior market cycles. We adapted our investment methods, so that market internals must always deteriorate explicitly in order for us to adopt or amplify a negative market outlook. Sufficiently extreme market conditions can still encourage us to take a neutral outlook, but we abandoned our willingness to adopt a negative market outlook until market internals have deteriorated explicitly.
In short, our response to “overvalued, overbought, overbullish” syndromes was the source of our difficulty in the recent speculative period, because these syndromes encouraged us to maintain an overly negative market outlook in the face of unrelenting speculation. In late-2017, we adapted so that market internals always take priority. We have become content to identify the presence or absence of speculative pressures, using valuations to gauge prospects for long-term market returns and full-cycle risks, but we have abandoned the belief that reckless speculation has “limits.”
Regardless of other market conditions, our adapted discipline now requires explicit deterioration in market internals before indicating a negative market outlook. Sufficiently extreme conditions can still encourage a neutral outlook, but most often, when our measures of market internals are uniformly favorable, our market outlook will be constructive as well.
Market conditions will change, and the outlook will change along with them. In particular, the strongest market return/risk profiles we identify are associated with a material retreat in valuations that is joined by an early improvement in market action. We strongly expect to adopt a constructive or aggressively favorable investment outlook in response to those conditions.
In the meantime, our hope and expectation is that our long-term investors, particularly those who were with us in complete cycles before 2009, will feel very much like an old, familiar friend is back at the wheel. Having made our adaptations, we will continue to adhere to a value-conscious, historically-informed, full-cycle investment discipline.