wheat vs. chaff (iii)

Stock prices move higher in bull markets for two reasons: company earnings are better than expected and the time horizon over which investors are willing to pay for future earnings gradually expands from a year or so to two or three.

Stock prices move lower in a bear market less because news developments are unexpectedly bad than because the market continues to discount and rediscount the same bad news over and over again. I have no idea why. Maybe it’s because the bad news only sinks in slowly. Maybe its because that’s all the news there is.

Both bull and bear markets both tend to end more on a judgment about stock prices that comes in advance of a change in the economic winds–that every bad (good) thing that can happen is already factored into today’s price, implying that the only sensible bet is that the next significant move is a reversal of the prevailing trend.

One strategy for coping with a bear market is to make your holdings look as much like the index as possible and wait for happier times. For investors like me, who have an up-market mentality, this is the first step to take. In my case, I never do enough, but some thing is better than nothing.

Every bear market has its own characteristics or themes, some of which will remain relevant as the market turns up. So for anyone willing to deal with the ugly reality of portfolio holdings generally going down, there are typically chances to reposition defensively in a way that also prepares for the next up market.

In the present case, the key general issues seem to me to be:

–the return of interest rates to normal as the pandemic recedes;

–the character of current inflation and the extent to which it will abate as the supply chain normalizes;

–winners/losers as the world shifts from stay-at-home to back-to-work; and

–the effect of Russia’s invasion of Ukraine on world commodities markets.

more tomorrow

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