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Tags: bull market | bear | stock | investors

The Bull Giveth, the Bear Taketh & You're Not Passive

The Bull Giveth, the Bear Taketh & You're Not Passive

(Dollar Photo Club)

Lance Roberts By Wednesday, 02 November 2016 10:16 AM EDT Current | Bio | Archive


Over the last several months, in particular, the number of articles discussing the shift from “active management” to “passive indexing” have surged.

I get it. The market seems to be immune to decline.

It is effectively the final evolution of “bull market psychology” as investors capitulate to the “if you can’t beat’em, join’em” mentality.

But it is just that. The final evolution of investor psychology that always leads the “sheep to the slaughter.”

Let me just clarify the record – “There is no such thing as passive investing.”

While you may be invested in an “index,” when the next bear market correction begins, and the pain of loss becomes large enough, “passive indexing” will turn into “active panic.”

Sure, you can hang on. But there will be a point where your conviction will eventually be broken. It is just a function of how much loss it takes to get there.

Over the last four years, as the Central Bank fueled surge in asset prices has climbed relentlessly higher, the psychological shift from active to passive management has gained ground. Unfortunately, this is a result of a psychological bias where recent performance is extrapolated indefinitely into the future. This is known as “recency or anchoring bias,” and is one of the primary factors that has the greatest effect on investor returns over time. As stated previously:

“However, in order to judge today’s market level, it is desirable, perhaps essential, to have a clear picture of its past behavior. Speculators often prosper through ignorance; it is a cliché that in a roaring bull market knowledge is superfluous and experience a handicap. But the typical experience of the speculator is one of temporary profit and ultimate loss.”

Yes. “YOU are a speculator.”

You have none, zero, nada, no control over the direction of an individual company, the index or the fund manager. You are simply SPECULATING on the price you paid for an asset that you HOPE to sell at a higher price to someone else in the future. That is, in its most basic form, a speculation.

The importance of that statement is that most individuals extrapolate past performance indefinitely into the future and become extremely complacent in managing for risk. This tendency is what leads investors to “buy high and sell low.”

The question that must be answered is whether this is just a bull market, or some sort of “new market” that will defy all previous experiences?

If this is just a bull market, then the term itself suggests that it is just the first half of a full-market cycle and eventually a bear market will follow.

Historically, full market cycles have finished when prices complete a “mean reverting” process by falling well below the long-term mean. Since the beginning of the secular bull market in the 1980’s the full “mean reverting” process has not yet been completed due to the artificial interventions by Central Banks to prop up asset prices.

There is an argument to be made that this is could indeed be a “new market” given the continued interventions by global Central Banks in a direct effort to support asset prices. However, despite the coordinated efforts of Central Banks globally to keep asset prices inflated to support consumer confidence, there is plenty of historic evidence that suggests such attempts to manipulate markets are only temporary in nature.

This can also be seen by looking at the rate of change in the S&P 500 index over a 72-month period.

The conclusion is quite simple. The current rate of change is in extreme territory and is exceeded only by five other market up-moves: the roaring bull market of the twenties leading into the Great Depression, the bull market of the fifties and the technology boom. Further, the trajectory of the up-move is similar to that of the market leading into the highs of 1929 and the highs in 1983. The spike in the ROC coming off the secular bear market lows of 1974, ended with the crash of 1987.

Such extreme movements in prices over a relatively short period, regardless of underlying circumstances, have all had similar outcomes. Consequently, investors should expect a similar outcome in the future. However, in the short-term psychology tends to overtake more logical thought processes as the “need for greed” keeps investors at the table long after the “cards have turned cold.”

Valuations also provide similar evidence that the current market is most likely no different than previous bull market cycles. The forward price/earnings (PE) ratio — the price of the S&P 500 divided by the expected earnings of those S&P 500 companies — is probably the most popular way to measure value in the stock market.

In theory, it tells us if the market is cheap or expensive relative to some long-term average. Unfortunately, since P/E’s are terrible at predicting short-term outcomes for the market, investors tend to quickly dismiss them as “being wrong this time.” Such attitudes have historically not worked out well for individuals.


What is important to remember is that for every “bull market” there MUST be a “bear market.” While “passive indexing” sounds like a winning approach to “pace” the markets during the late stages of an advance, it is worth remembering it will also “pace” just as well during the subsequent decline.

Oh…so you say you’re going to “sell” those “passive ETF’s” before that happens?

Well, then you are not so “passive” after all.



Lance Roberts is a chief portfolio strategist and economist for Clarity Financial.


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Over the last several months, in particular, the number of articles discussing the shift from "active management" to "passive indexing" have surged.I get it. The market seems to be immune to decline.
bull market, bear, stock, investors
Wednesday, 02 November 2016 10:16 AM
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