Resisting the Horn of Doom
Board: HG Philosophy
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It is hard in a long post to continually say “IMO” and do all the usual caveats. Please understand that this post just presents my point of view; I truly respect yours as well, and I understand and quite honestly believe that what is right for me may not be right for you. All of this is IMO!
John Hussman has been sounding the horn of doom for years now, and anyone who had paid attention back when he started to do so would have missed out on very large gains in the market. With that caveat, I still think it is worth pondering his latest essay:
June 9, 2014
We Learn From History That We Do Not Learn From History
John P. Hussman, Ph.D.
I would like to direct your attention to three ideas:
1. Markets go in cycles, and the day will come when we once again have a bear market.
This is not controversial at all; it is purely a matter of when, not if. But “when” is critical – unfortunately, no one seems to have a crystal ball.
2. We forget how terrible a bear market can be, and how hard it is to resist the urge to panic.
Everybody talks a good game when times are good. As we hum along to ever-higher new highs, we occasionally have a 2% dip and all the brave souls throughout Fooldom all spout the same tired, hackneyed phrase: “Be greedy when others are fearful . . . “ and purchase stocks with relish, proud of their savvy and fortitude.
Yes, we are all analytical, resolute and tough when we get the hiccups – but how about when the smallpox epidemic hits? I guarantee you, right now, that most of our tight-lipped Clint Eastwood types will turn into screaming nervous Nellies when the real thing rolls around – and it will, someday.
I think it is a very good exercise to remember what a bear market actually feels like, and to try to imagine how we will react when it comes. Here is Hussman:
On the subject of risk tolerance, recall that a typical, run-of-the-mill cyclical bear in the stock market comprises a loss of about 32% (though the most recent bear markets have been far worse).
OK, tough guys and gals, think about that. Your $200,000 account will suddenly have lost $64,000 – even though you did everything right. You followed the rules, you stayed the course – and your $200,000 has turned into $136,000! And it is sinking like a stone! Is this the end? Can you endure another huge drop? Should you sell? Your whole life is in jeopardy – the kids’ college funds, the retirement plan . . . .
Back to Hussman:
Remember also how compounding works. A 32% loss turns a 100% gain into a 36% gain. The 55% market loss in 2007-2009 was equivalent to an initial 25% loss, followed immediately by an additional loss of 40% from there. At market peaks, investors easily forget the extent to which bull market gains are erased over the completion of the typical cycle.
My advice to you, my friends-of-the-boards, is to avoid over-rating yourselves, as I am trying to do. Do not assume you are different than everybody else and can easily withstand the pressures of a bear market. Envision how it will feel, understand how hard it will be, and prepare yourself now for those emotions.
Hussman goes on:
A reminder: The first sell-off in the typical bear market averages 10-12%. By that point, investors often feel that stocks have declined too far to sell, and are heartened by the partial recovery that typically follows. The same sequence generally repeats many times over, with one or two much deeper free-falls along the way. . . . .
Regardless of whether the market’s losses in this cycle turn out to be closer to 32% (which is the average run-of-the-mill bear market loss) or greater than 50% (which would be required to take historically reliable valuation measures to historical norms, though most bear markets have continued to undervalued levels), it’s going to be difficult to avoid steep losses without a plan of action.
Yes, one very acceptable plan of action – one even endorsed by Hussman -- is to be IN FACT a resolute buy and hold investor. Weather the storm, take your hit, stay fully invested, do not panic and sell, and over time the next cycle will do its magic and you will be OK. Of course this may take ten or more years, which is why you need to have cash reserves sufficient for your circumstances.
A large problem with this approach is that most people overrate themselves; they think they are tougher than they are. And, when things are darkest, and terror is very real, and it seems as if there is no bottom in sight, no end to the losses – these people sell, ensuring that the disaster is permanent.
Be honest with yourself: are you that weak-kneed person? I am pretty sure that I am. I have been through a few of these and I have not done very well. I panic and sell – I know I should not, but the storm just goes on and on and on and it seems that it will never end, and sooner or later I say to myself, “Holy Bleep, I have got to get out and save something; I will reinvest when the market has lost another 20%!!”
You know how that turns out.
3. If you cannot ride out the storm, prepare yourself now for a different approach: panic early, while the exit doors are not crowded and the damage has not occurred.
Wow, this is radically unpopular advice in the MF universe. Here we are, sitting in the horn of plenty, gobbling down grapes and persimmons and those little hot dogs wrapped in soggy bacon, and swilling down flagons of Coca Cola, basically having a great time while slowly killing ourselves at a nutritional level – and this idiot over in the corner is saying, “RUN FOR THE EXITS!! FIRE ON THE MOUNTAIN!!THE HYKSOS ARE HERE!!!”
And I admit it; I am doing exactly that, as is the brilliant, estimable and perpetually wrong Hussman. I am sitting on huge gains; my accounts are larger than I ever dreamed they would be (since I am a horrible investor), and I am just fine with where they are. I would have been happy to reach these levels by 2020, if you had asked me four years ago.
And as I query myself about how I will do when a bear market hits, I realize I will fold like a cheap tent. I will hold and hold and hold, following the well-meaning exhortations of everyone here, until the very darkest days, when I will sell in utter panic.
So, forget that; I do not like that future. I like a different future -- the one where I (i) go over my holdings with a very critical eye, selling everything that will look unappealing to me if it sinks like a stone in a market decline, (ii) sell enough of everything else so that I am 50% in cash, (iii) sell all my big losers, no matter what, to generate tax losses to cover some of the gains from the other sales(after all, if they are losers in this market, what hope do they have in a bear market?), and (iv) put on a hedge covering half of my remaining market exposure (in my case a short of SPXL).
I know this is not optimal, but I actually could care less -- I can sleep comfortably through any likely future, including one where I miss massive additional gains, and I know that I am avoiding the doom that almost certainly awaits if I try the MF way through a real bear market.
In our view, that [plan of] action should be rather immediate even if the market’s losses are not. However uncomfortable it might be in the shorter-term, the historical evidence suggests that once overvalued, overbought, overbullish conditions become as extreme as they are today, it’s advisable to panic before everyone else does.
BTW, here are the big losers that I sold; I will evaluate repurchasing them in 30 days:
MTY (Toronto ticker)
Any thoughts on the merits of these stocks at these (relatively) depressed prices?