Another 50% Decline?

A long time reader left the following;

Dr. Hussman has been convinced that we are going down 50% yesterday. i expect his next post to be written in a bomb shelter. The man is really bright, and a deep thinker. What do you see that he is missing , or vis versa?

John Hussman has influenced my approach in a couple of ways as I have spelled out many times before. He thinks in terms of the entire stock market cycle and weighs the current environment for risk factors and positives to draw a conclusion that determines how he constructs the portfolios he manages. In terms of walking the walk on taking bits of process from various sources to create your own process, the above is what I take from Hussman.

My recollection is that more often than not over the course of many years he has weighed the positives and negatives and drawn a negative conclusions (this blog popped up on his radar once so Dr. Hussman feel free to correct me if I have this wrong).

Where I differ with Dr. Hussman is that don't rely as much as should happen as I believe he does. Based on the fundamentals I would say there is no way the market should have gone up anywhere near the amount that it has in the last 40 months but it has, the SPX has more than doubled. I have said many times before that market history is full of examples of the market doing what it shouldn't.

I believe my use of the 200 DMA (which comes from Jim Stack) addresses this. If a 50% decline is coming to an S&P 500 near you then it will get there by way of 1316 which is where the 200 DMA is currently. While it is vitally important to be disciplined to whatever strategy you use it is also important to assess current events when you do take defensive action (assessing current events obviously needs to be done constantly). In late 2007/early 2008 the yield curve was inverted, the 2% rule (which comes from Ken Fisher) was kicking in and the 200 DMA line was sloping downward all in addition to the breach.

Those are all market indicators and of course fundamental indicators were not looking good either. To me this was reason to not give the benefit of the doubt to the market and to move a little more aggressively toward defense. The last couple of summers there were fewer negatives in place when the 200 DMA breaches occurred. This meant staying disciplined first and foremost but allowed for being less aggressive with defensive action.

If a strategy relies too much on what should be based on the fundamentals then you might convince yourself to never have any net long exposure. But as mentioned above the fundamentals stink for lack of natural demand created by many desperate policies enacted by the Fed and Treasury and yet the market is up a lot in the last three years (repeated for emphasis).

As for the market possibly dropping 50% for a third time since the tech bubble, this has a low probability in my opinion. 50% declines in developed markets don't happen that often. That it happened twice is truly stunning but it happened so it can happen a third time, I just think the probability is low. I also believe that the market will give multiple warnings that the chances of a 50% decline have increased as was the case in the tech wreck and then the financial crisis. In that light I believe you can wait until the market does warn of a large decline in the manner I describe above.