Your Brain Can't Handle the Stock Market
We have said a good deal in this space about the futility of trying to time short-term market moves (see e.g., this, this and this). No one has demonstrated the ability to do this consistently over time. While it is possible to avoid the very largest of collapses over long periods of time using a simply trend-following approach (see Meb Faber’s "A Quantitative Approach to Tactical Asset Allocation"), the shorter the time horizon, the more difficult this becomes.
Thus, forecasting near-term market moves is an exercise in futility.
I bring this up because after a pullback of less than 10 percent in September and October, markets have powered ahead. Despite all of the crash warnings, the Standard & Poor's 500 Index has managed an 11 percent gain this year. Yes, I know, a 1987-like crash, is imminent; I have been hearing that for five years. Like the boy who cried wolf, should a crash finally occur -- and that is always a possibility -- you won’t get credit for it.
In trading, early equals wrong. That is why the old strategist's joke is that it's OK to forecast a price target or a date, but never to give both at once. Even the absurd forecast of Dow 36,000 or Dow 100,000 will be right eventually, if you are willing to wait long enough. Just ignore the original dates offered by the authors.
There has been lots of skepticism about this market, practically from the day it began rising from its lows in March 2009. I have been calling this “the most hated rally in Wall Street history." And it still is.
What else is going to end this bull market? That we have hyperinflation in the Hamptons? A forecast that there is a 65 percent chance of a recession made by the grandson of someone who predicted the 1929 crash? Or someone declaring a “1987-like crash was imminent” (slide 41) every year since this rally began?
The financial media and the blogosphere of which I am a part, contributes to this. There are numerous newspapers, many magazines, three major financial news networks, and countless websites all of which have endless space and 24 hours of airtime to fill each day. Too many of them have told you why you must “get out of stocks now.” At some point in the future, one of them will by random chance be right.
These were the same folks who in 1999 were relentless cheerleaders for ever-rising, earnings-free dot-com equities. Hedge-fund manager Bill Fleckenstein liked to call this the “bubblevision” crowd.
All of noise today is contributing to a massive amount of negativity. This isn't anecdotal; it has been objectively measured by someone whose sole focus is investment sentiment readings. The reason for this is that we constantly fear the wrong things. Humans are a mess of cognitive errors. Our wetware is designed to keep us alive, not to ride out the ups and down of the capital markets. The net results of this deficiency show up in investors' long-term returns, which by and large are awful.
That is why on a regular basis I feel compelled to remind readers that they just are not built for this.
The good news is that enlightenment and self-knowledge leads to improvement. If you are aware of your cognitive errors, if you know what you are doing wrong you can at least put into place steps to ensure you are no longer your own worst enemy.
The bad news? It's really hard to do.
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Barry L Ritholtz at email@example.com
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