What to Hope for in a Bull and Bear Market


Of the seven deadly sins (lust, gluttony, greed, sloth, wrath, envy and pride) only one is no fun. By the end you should have a good idea which one it is…

Since their introduction, exchange traded funds (ETFs) have become incredibly popular. In just 25 years, more than US$3.5 trillion has jumped into ETFs.

And why not? For most, pouring through financial filings is worse than being alone with their own thoughts.

So why bother when you can just buy a basket of assets and forget about it? Such an argument is even more compelling if those assets are rising at the same time.

For most stock markets (not ours), the run since 2009 has been euphoric. If we look at the example of the US, indexes have exploded.

The S&P 500 is up 246%, the Dow has climbed 173%, and the NASDAQ has skyrocketed 331% since their lows in 2009.

You could blame the runs on excessive money printing by US Federal Reserve. Or you could chalk it up to the long-term success of American business.

Either way, it’s helped funnel trillions into passive investments (ETFs and index funds).

And there are two businesses that couldn’t be happier.

More than 8-times the size of Aussie GDP

Blackrock and Vanguard are the two biggest asset managers in the world. Between the two are US$10.7 trillion in funds. It’s more than 8-times the size of Aussie economic output in 2016.

Bloomberg wrote:

Investors from individuals to large institutions such as pension and hedge funds have flocked to this duo, won over in part by their low-cost funds and breadth of offerings. The proliferation of exchange-traded funds is also supercharging these firms and will likely continue to do so.

Global ETF assets could explode to $25 trillion by 2025, according to estimates by Jim Ross, chairman of State Street’s global ETF business. That sum alone would mean trillions of dollars more for BlackRock and Vanguard, based on their current market share.

But I suspect many investors flock to passive strategies, not because they don’t like hard work (sloth). They cannot stand to watch others get rich, while they earn little to nothing. 

Of course investors won’t admit it, but most like to chase returns. They jump into the higher returning stock, asset or fund. As soon as returns drop, they sell out and look for the next highest returning stock, asset or fund.

The problem with this strategy is it leads investors to buy at highs and sell at lows. Not the best strategy to have.

Investors would be far better off to instead hope for average returns in bull markets and outperformance in bear markets.

It’s the advice Warren Buffett constantly told his investment partners from 1957–69. And he didn’t do all that bad.

Temperament, not intelligence

In his 1962 partnership letter, Warren wrote:

I think you can be quite sure that over the next ten years there are going to be a few year when the general market is plus 20% or 25%, a few when it is minus on the same order, and a majority when it is in between.

I haven’t any notion as to the sequence in which these will occur, nor do I think it is of any great importance for the long-term investor.

‘…Our job is to pile up yearly advantages over the performance of the Dow without worrying too much about whether the absolute results in a given year are a plus or a minus.

I would consider a year in which we were down 15% and the Dow declined 25% to be much superior to a year when both the partnership and the Dow advances 20%.

Essentially Buffett is saying it’s OK to miss out on raging bull markets. Underperformance over the short-term doesn’t matter all that much.

What’s far more important is that you keep control of your losses. When you find yourself in a bear market, that’s when you should be trying to outperform.

To stress the point of avoiding losses, let’s look at two investors. Investor A more or less follows the market. He buys the biggest hottest stocks and lives with the ups and downs of the market.

Investor B is far more conservative. He lags the market as it runs up. And for that, his performance during bull markets looks terrible. But it’s in bear markets that Investor B really shines.

Market Returns A vs. B over 10 year period. 03-04-2018

[Click to enlarge]

The long-term returns speak for themselves.

So why doesn’t everyone hope for the average in bull markets and outperformance in bear markets?

Like I said, they can’t bear watching their ‘dumb’ neighbour get rich off stocks while they earn average returns in the short-run.

It’s why Buffett says investors don’t need super intelligence. Temperament is far more important. You have to be willing to go against the crowd and look dumb when everyone else is making money.

During the heights of the internet bubble, investors counted Buffett out as an old, confused has-been. While everyone was getting rich off internet stocks, Warren was sucking his thumb, or so investors thought.

Of course we now know how that all turned out.

Clearly there’s a huge advantage of looking dumb in the short-term. Oh, and did you work out which deadly sin is no fun?

Your friend,

Harje Ronngard,
Editor, Money Morning

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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