Investors love Bull Markets and hate Bear Markets. Big surprise. But in my view it’s a badly misguided sentiment, for two reasons. First, the seeds of most serious, permanent losses of capital are planted not during Bear Markets, but during Bull Markets. Second, the only time you can reliably buy an investment asset with a strong likelihood of a sound return is during Bear Markets, when prices are cheap, not during Bull Markets, when prices are expensive.

Let’s look at these two claims in more detail.

The Seeds of Loss

During Bull Markets, investors get greedy. The market is rising and everyone we know is making loads of money. People we would normally view as complete idiots are getting richer every day. So we do two things, both of them bad. First, we allow the risk asset portion of our portfolios to grow along with the rising markets. If, during normal markets, we had a portfolio with 65% in stocks and 35% in bonds, now that we are riding the Bull we allow the stock portion to rise inexorably. Soon we are at 70% stocks and 30% bonds, then 75% stocks and 25% bonds. I.e., we’re not rebalancing back to our target portfolio.

Then, if the Bull continues, we compound our mistake. Seriously unbalanced by greed, we now take money out of what remains in our bond and cash portfolios and invest it in stocks. Soon we are at 90% equities and climbing. We’re getting rich! What could be wrong with this picture?

Back in calmer days, we knew how much risk we were prepared to take. That risk was embedded in a portfolio with 65% in stocks. But now, having forgotten all about risk, we wake up one morning and find that we own a vastly more risky portfolio. Then, when the market turns on us, we get clobbered by a double-whammy. First, when the markets drop 50%, we lose not 50% of 65%, but 50% of 90%. Second, since at the top of the market we owned a portfolio that was vastly too risky for us, we now bail out of the market altogether (usually right near the bottom) and stay out. We miss the entire recovery, immortalizing our losses.

But it wasn’t the Bear Market that killed us, it was our dumb behavior during the Bull Market. The moves we made during the Bull preordained the losses we’d incur during the Bear.

Buying Things When They Go on Sale

While no one can predict the short-term direction or velocity of the markets, we do know something about valuation. Stocks, for example, sell for about fifteen times earnings on average. If we pay less than that, we are likely to do well, and if we pay more than that, we are likely to do less well. If we pay a lot less, we are likely to do very well, and if we pay a lot more, we are likely to do very poorly.

So what do investors do? They do the exact opposite of what makes sense. When stocks are selling cheaply, as during Bear Markets, investors are running for the sidelines, convinced the world is going straight to hell. When stocks are ridiculously expensive, as during Bull Markets, investors can’t get enough of them.

So if you’re a sound investor, you should pray for Bear Markets. True, you’ll get hurt as prices fall, but not worse than you can tolerate. Then, when prices are cheap you can load up. When the round trip is complete, you’ll be a lot richer.

If you’re an unsound investor, you should also pray for Bear Markets. Why? Because a Bull Market will kill you when it turns on you. True, you won’t buy during a Bear Market, but at least you’ll still be alive.

That’s the trouble with Bull Markets.

Next up: Is the Fed Like a Bad Knee Doc?

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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.


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