We’re an excitable species. Especially when it comes to money, a god of our own creation who we both worship and chase as a matter of course. For the vast majority, money is elusive. The more we chase it, the faster it runs.
We can’t help but clamor after it, though. When we get a whiff of it (and new money does have that distinctive smell), we’re single-minded in our pursuit. All other considerations are secondary. That, despite knowing (some of us through extensive experience) that it’s never “enough.” Money is a cruel god. Of all the wicked jokes it plays, the most tyrannical involves psychological manipulation. Most of us have an idea about what would constitute “enough” money. The fortunate few who manage to accumulate “enough” almost immediately discover that, without their consent, money moved the goalposts. “Enough” becomes some larger sum. And so money drives men and women to madness.
It’s through that lens that equity rallies like Tuesday’s should be viewed. Even the most jaded strategists — the veterans with job security and the leeway to lean bearish in perpetuity — would rather a rally than a crash. After all, they’re long stocks in their retirement portfolios. Sure, there are plenty of gamblers out there with positions that benefit from big declines. Bridgewater is short European equities again, to cite a recent high profile example. But most of us get excited by the sight of green screens. And besides, shorts suffer from the same affliction as everyone else. Contrary to some of the absurdist yarns they spin about doing the investing public a “service” by acting as a counterbalance in a world of unscrupulous executives (at the single-stock level) and blind bullishness predicated on “groupthink” (at the macro level), they’re just chasing money too. They don’t care about “keeping them honest” (in some cases shorts can’t even tell you who “them” is), nor do they care about acting as a proxy for price discovery in a world devoid of it. Bears care about money. Just like bulls.
This mental affliction of ours makes us want to believe, especially during rallies. “Maybe the bottom is in!” we’ll say. But the same irrationality that “informs” hope likewise precipitates despair when risks materialize and manifest in bad outcomes. Hope causes us to chase flimsy rallies higher while despair compels us to drive oversold markets lower. Virtually no one gets it exactly right. That, more than anything else, explains why market timing (calling tops and bottoms) is impossible: We’re never totally rational when money is involved.
There’s an inherent paradox in all of this. JonesTrading’s Mike O’Rourke captured it well. The notion that fund managers are “max bearish,” as conveyed by the July vintage of BofA’s Global Fund Manager survey, “was more than enough to spark a market rally that nobody is, or should be, willing to stand in front of,” he wrote. The figure on the left (below) illustrates pervasive pessimism.
The upshot: It’s often not advisable to fade human irrationality when it comes to money. Irrational people, acting in concert, can perpetuate outcomes that otherwise make little sense. In some cases, then, the rational thing to do is follow the crowd into irrationality or, at the least, eschew the temptation to bet against them. Sometimes, it’s best to stay out of the way. As O’Rourke put it, “let those who will chase take them as far as they will go.”
The figure on the right (above) suggests that perceptions of liquidity reflect actual conditions, which are dire. And not just because of any summer doldrums. Market depth is severely impaired. In equities, it never recovered from the implosion of the VIX ETN complex in February of 2018, and analysts have spent most of this year lamenting similar trends in Treasurys. Such conditions are conducive to exaggerated price action.
It’s important to note (and I discussed this at some length last week) that there’s been no “capitulation” in equity fund flows. That matters. Equity funds have taken in a net $181 billion in 2022 (figure below).
Obviously, there’s no ironclad rule that says equity funds “must” see massive outflows before stocks can sustain a rally, but looking back over the past dozen years, strong rallies typically followed large outflows.
“We have not yet seen capitulation in outflows from equity funds,” Bernstein’s Mark Diver and Sarah McCarthy said Wednesday, calling flows to stocks “remarkably resilient.”
That stands in stark contrast to aggregate measures of sentiment and positioning. As most readers are likely aware, BofA’s “Bull & Bear Indicator” is still stuck at 0.0, and the 50-day rolling average on a Nomura gauge of equity sentiment sat in just the 1.9%ile (since 2004) at the beginning of the week (figure below).
“Historically, it hasn’t been worse than this over the past two decades,” the bank’s Charlie McElligott said, of the sentiment index.
He also mentioned “general fatigue from downside catalysts,” and noted that “with positioning and economic cycle vibes already so ‘trashed,’ we are now far more concerned about missing the equities upside ‘right’ tail than a new escalation of the downside ‘left’ tail.”
Chase if you must.
I think you just coined a new definition!
re·pub·li·can
Learn to pronounce
noun
plural noun: republicans; plural noun: Republicans
1.
“Irrational people, acting in concert, can perpetuate outcomes that otherwise make little sense. ”
– therealheisenberg
De-mo-crat: “Rational people, talking in concert but never implementing outcomes that make sense.”
Independent: “Love me some chaos.”
De-mo-crat :
1.
“Rational people, arguing over exactly what to do to create outcomes that solve problems, but never actually coming to an agreement on any subject”
2.
“Everyone who isn’t on the far right of American politics in the 21st century.”
3.
“A person who is vilainized and blamed for every single problem that exists or purports to exist in American society regardless of official party designation. Also known as the enemy of the people.”
uncle!
Keynes had a treatise on this subject in one of his books- the goal in investing, and I will paraphrase is to guess where the crowd thinks the rest of the crowd is going. The hockey metaphor is Wayne Gretzky who had an instinct to know where the puck was going to go before all of the other players. It is rational even though when you really think about it, it can lead one to irrationality. Anyway, you can choose to play the game if your time horizon is reasonably short. Or you can eschew the game and be a long term investor, and look at your risk tolerance, time horizon and spread your risk.
I for one am willing to say that I am completely wrong footed (but at least not foolish enough to use leverage and shorts).
This (bear) market rally, slight housing declines = “bad news is good news”, ought to nudge the Fed to realize they haven’t soaked up their excess Trillions yet (not that they watch Market 😉
I’m happy for all of those who realize their gains, just as I have realized my losses.
My first full time job after 21 years of education was in 1970, a teaching job at a nice middle of the road regional state university. I got slightly overpaid because they needed my skills. I soon realized that although I made more than some I also made much less than others. At that point I decided that the deal I had made me comfortable so I decided not to worry too much about deals other folks had. My daughter and her husband each make much more than I ever did, even with an endowed chair and forty years of experience. For the rest of my life I have been quite comfortable with the idea that having enough assets and income to do what suits me is just fine. I have never beaten the market in stocks, although for 25 years my bond investments beat the heck out of the stock market. My portfolio sits right on the bottom third of the efficient frontier and my income rises every year, even though I currently donate 25 percent of my income to worthy charities (I hate capital gains). For me money has always been about comfort and self-sufficiency. When I was a kid my cousin down the street always had the more expensive toys, and more of them. He became a lawyer, married old big money — she is a dynamite lady, btw. He always made more money than me but he spent so much that he didn’t keep much more than me and I learned early in the game that finding a way to make what you had meet your needs was great. Anyway, he has gout and can’t sleep without a Cpap machine. We all get what we get so work with it. I will say, the first time I lost 5 figures in a day scared the crap out of me. But some days it goes the other way and like a big city cop I learned to get through those bad days.
Thanks for sharing your hard earned wisdom.
I have only lost 4 figures in a day so far while learning the game (I think I’ve seen 5 figures once but it’s an account that’s long term investments and recovered in a year) and ultimately I hope to get better but I know that losing these made up “points” isn’t life… life’s what happens when you work to make money (and the people you spend it with who don’t care about your money).
https://youtu.be/ITs-YX1yQ7o
Your article reminded me of this scene from one of my favorite movies, Key Largo.