Interview: John Hussman

Among mutual fund managers, John Hussman, who runs Hussman Strategic Growth (symbol HSGFX), has one of the best records of correctly judging when stocks will pay off and when they'll deliver lemons. From its inception in 2000 through June 5, Hussman's unconventional fund gained 8.9% annualized. Over the same period, Standard & Poor's 500-stock index lost an average of 3.1% per year.

KIPLINGER'S: Do you consider yourself a market timer?

HUSSMAN: No.

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How does what you do differ from market timing?

I don't believe that investors can pick bottoms or tops, or forecast the market's direction over a short period. I do believe that when stocks are cheap, they tend to produce higher returns over a horizon of seven to ten years, and when they are richly valued, they tend to produce poor returns. Over shorter periods of time, valuations still matter, but investors' willingness to bear or avoid risk becomes much more important to the market's likely returns. I try to identify prevailing conditions in the market.

What indicators do you follow?

On valuation, I compare stock prices of the overall market with the long-term stream of cash flows I expect the underlying companies to generate. The best way to identify investors' attitudes toward risk is through market behavior, as evidenced by technical indicators.

For example, a market that advances on strong volume across a wide spectrum of individual stocks, industries and security types indicates investors' willingness to accept risk. When you see trading volume shrink as the market advances but expand as the market declines -- or when you see that uniformity of advances across sectors break down -- it's a signal that investors are becoming more risk-averse. This can happen even when the overall market is hitting new highs.

How do you put your views to work?

Strategic Growth is usually fully invested in a diversified group of individual stocks, but I can hedge by selling short the S&P 500 and other indexes using index futures or a combination of put and call options. However, this is not a bear fund, so the value of the fund's short positions will never exceed the value of its long stock holdings.

How is the fund positioned now?

It is fully hedged. [In early June,] with the S&P 500 at about 940, stocks are slightly overvalued. They're priced to deliver total returns of 8% annually over the next decade. Also, the advance we've seen over the past few months has been gradually losing support.

Are you suggesting we're on the verge of another tumble?

No, that's not a forecast that stocks must or will go down, just that the market's risk-reward profile now isn't particularly favorable. If you look at post-crash markets, they don't usually form a V. The market crashes, you have huge advances off the lows, stocks settle down and then you have another advance.