time in the market vs. tim-ing the market

This, one of the many old saws that spout from the mouths of professional investors and investment advisors, is about how to achieve stock market success. It’s also an observation about the behavior of US stocks as the economic cycle progresses.

The turn from bearish to bullish tends to take most investors by surprise. Because of this, the first evidence of a change in the current bad fortune tends to result in a tectonic rush to exit defensive positions (whose main virtue may be that they won’t go down much) and to acquire beaten-up cyclical growth names.

Historically, a disproportionately large part of the up that occurs in the new cycle will happen during a small number of very strong days during this transition. This all comes well in advance of confirming evidence in company quarterly earnings reports–and also well before investors–retail or professional–who have raised large amounts of cash or otherwise assumed a very defensive position can convince themselves to react.

Why do things happen this way? I’m not 100% sure.

–one part is certainly relative risk/reward. If defensive stocks are very pricy (so arguably they won’t go up a lot) and more economically sensitive names are really beaten down (and arguably can’t decline much more) it makes sense to take money out of the first group and put it into the second. As first movers act, the relative value relationships change and buyers who were waiting in the wings emerge

–another may be information, high- or low-quality, that radiates out from the world at large (we’re reopening/expanding) or work (we’re hiring/bonuses are back) or just about anywhere else

–for a mutual fund manager, a surge in inflows is typically a sign of at a top for fund performance; a rash of redemptions usually means the opposite

–a typical bear market lasts a year or so

I think we’re more or less in this situation now now.

What I see:

–measured by the S&P 500, the market has fallen about -28% from its high in December 2021 to what may be the ultimate lows this September. The decline in NASDAQ has been more like -35% over the same span. The S&P performance is in the range of a garden variety down market; NASDAQ is a bit worse. The clear, and unusually deep, losers in this market have come from a set of “concept” stocks like those held in ETFs like ARKK, which is off by 70% from its January 2021 high.

There have been three post-WWII bear markets deeper than this one has gotten so far:

1972-74, which featured the collapse of the post-WWII financial order + the first oil shock + the bankruptcy of the UK; S&P lost 49%

2007-09, the Great Financial Crisis, with massive fraud by bank employees threatening the solvency of global banking system, causing world trade to grind to a screeching halt, triggering widespread layoffs; S&P lost 57%; and

–the aftermath of the internet bubble in 2000; during which the S&P lost 49%.

The first two of these situations were, to my mind, clearly far worse economically than where we are now. The Internet Bubble comparison is harder to judge.

–what’s similar between IB and today:

—a high level of tech-related speculation, with subsequent market collapse;

—a 25% rise in the crude oil price from mid 1999 to end 2000.

–what’s different:

—– substantial fraud in internet stocks–Henry Blodget of Merrill Lynch, most heralded internet analyst of that time, censured and permanently barred from the securities industry for issuing fraudulent research touting internet stocks;

—–newly public startups begin to run out of money;

—–massive telecom overcapacity develops quickly, as many firms rushed to create fiber optic cable network systems rendered almost immediately uneconomic by duplication and technological advance (deep wave division multiplexing);

—–accounting scandals among major companies (Enron, Worldcom, Qwest, IBM, KMart, Bristol Myers Squibb, Lucent…);

—–Microsoft found guilty of anti-trust violations;

—–2000 introduction of the euro, causing recession in much of the EU;

—–continuing recession in Japan, at that time still a major world economy;

—–9/11/2001 attacks

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