Manias, Panics, And All-Time Highs
We’ve seen a lot in the last two weeks: Manias, Panics, and All-Time Highs.
Manias
Dry Ships Inc. (a shipping company) went from $4 to $102 in 4 trading day following the election, an astounding gain of over 2,000%. There were a wide variety of reasons attributed to the advance (Trump is bullish for growth/shipping, a positive debt restructuring, a rally in the Baltic Dry Index, an epic short squeeze, etc.). The reasons don't matter so much except that they create a fundamental rationalization for the mania to take place.
As Dry Ships was approaching $100, I conducted a poll on twitter asking where it was headed next ($200 or $50). This was the response…
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Interesting. Most said lower but 37% said it would double yet again.
What happened next? Dry Ships was halted on the 16th and when it reopened on the 17th it proceeded to fall 85%, giving back almost all of the gains.
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Lessons:
- As long as human beings have emotions, there will be manias.
- We are not rational in our decisions, which is why the markets are not entirely efficient.
- We are induced to buy through a fear of missing out, among the greatest fears in investing.
- Manias are possible because people buy into to the greater fool theory, where they’ll be able to sell at a higher price to a “greater fool.”
- No one believes they are the greater fool.
- The price you are paying during the mania becomes irrelevant: “buy high and sell higher” is the maxim.
- The odds of you timing a mania successfully are not high. This suggests most would be better off watching as a spectator and letting the greater fools trade among themselves.
Panics
Following the election, we saw a good old-fashioned panic in global markets. At one point, S&P 500 futures went “limit down,” a 5% decline. Gold was up over 4%, 30-year Treasuries were up 1% (yields down), and the Dollar Index was down 2%.
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Did it stick?
No. Literally everything would soon reverse course, except for the sharp decline in the Mexican Peso. U.S. Stocks rallied, the Dollar surged, Gold declined, and Treasuries sold off (yields spiked).
By the next morning, S&P 500 futures were flat. The market opened as if the overnight panic never happened.
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Lessons:
- Panic selling is rarely rewarded in the short-term and never in the long-term.
- Panic should be embraced because fear tends to create opportunity.
- If you are going to sell, better to do so calmly and with a plan before the panic sell-off than with emotion during it.
- If you were panicking on election night based on a 5% decline, you need to reevaluate your risk tolerance. You are likely holding too much stock as the S&P 500 has historically had at least a 5% correction 3-4 times per year.
- The markets and their initial reactions to events are not always right, far from it. They can be very wrong because investors are acting not on information but emotion. We learned that back in June after Brexit and again after the election.
All-Time Highs
The S&P 500 hit an all-time high today (total return). Does that mean anything?
Perma bears are saying it does: “this is a sign of a frothy market; it will not end well.” They have been saying so since April 2012 when the S&P 500 first hit a total return high following the worst bear market since the Great Depression. Since then we have seen 176 more all-time highs, including today.
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The truth is that all-time highs, by themselves, are signaling nothing other than a market that has been going up. Just because every bear market has started from an all-time high doesn’t mean that every all-time high is followed by a bear market. Far from it.
The S&P 500 (total return) is at an all-time high roughly 8% of the tip since 1928. The forward returns following all-time highs are actually slightly above average from 1-month through 5-years (exception: 3 years). The percentage of positive forward returns is above average from 1-month through 1-year and slightly below average at 3 years and 5 years forward.
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Lessons:
- All-time highs generate many emotions that run contrary to reality.
- There is nothing inherently bearish about all-time highs based on the data. They are like most other days which tend to see positive returns going forward.
- All-time highs tend to be followed by more all-time highs.
- “Tend to” is far from always. There will be an all-time high in the future that will be “the top” before a 5% correction, 10% correction, or bear market ensues. That day could be tomorrow. Neither you, nor I, nor anyone else is good at predicting such things.
- Making wholesale changes in your portfolio based solely on an “all-time high” probably isn’t the best idea.
- You don’t need to have an opinion on all-time highs to make money as an investor.
Disclaimer: At Pension Partners, we use Bonds as our defensive position in our absolute return strategies for all of the above reasons. Bonds have provided a more ...
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