Tuesday, May 30, 2006

Hussman Weekly Market Comment: Apples to Elephants

Hussman Funds - Weekly Market Comment: May 30, 2006 - Apples to Elephants: "As for the long-term picture, the current reality is that stocks remain priced to deliver fairly unsatisfactory long-term returns to buy-and-hold investors in the major indices.
What is the long-term? Well, one way to think about that is to think about stocks as a claim on a long-term stream of future cash that will be delivered to investors. In the fixed-income market, a bond might deliver some of its interest payments in the early years, some in the later years, and finally a lump sum at maturity. The "duration" of a bond is basically the "average date" at which those payments come in (weighted by the proportion of the total bond value that's delivered at any given point). So a 10-year zero-coupon bond would deliver it's whole value at year 10, and so would have a duration of 10 years, while a 10-year, 6% coupon bond priced at par would have a duration closer to 8 years.

What's interesting about duration is that it's also the horizon over which you can best predict your future wealth (assuming you reinvest your interest or dividends), regardless of where the stock or bond market goes over time. That's why buy-and-hold investors should generally try to match the duration of their investments to the duration of their obligations. In effect, duration is the most appropriate definition of "long-term" in the sense of making the final value of a buy-and-hold investment relatively independent of the path that the market takes over time.

As it turns out, a good estimate of stock market duration is simply the price/dividend ratio of the S&P 500. That sounds like an implausibly magical fact, but there's a good amount of mathematics behind it (the February 23, 2004 weekly comment includes a detailed discussion on duration in the stock and bond markets).

Read the rest to find out the market's current 'duration'.


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