How quickly we forget

Humans are myopic by nature. Market participants move in tandem through waves of cautious optimism, to irrational  buying exuberance,  to speculation – and then reverse direction into doubt, and ultimately sheer panic selling. A commonality of the irrational exuberance (topping stage) and the panic (crash) stage are the attitudes of market participants. A common rally call of the crowd at market tops AND bottoms is “This time is different”. Having been through two major crashes (and several large corrections) over my 28 years in the industry (not to mention the prior years of investing on a personal basis), I have experienced this “new paradigm” attitude of crowds a few times.

Investors forget the signs leading into a crash. They participate in the madness. Yet in the moment of experiencing a crash, they cry “Never again”. Next time, they say, they will be wary of an over exuberant market. “We won’t be fooled again” they cry – right at the market bottom.

But they are fooled again. Because market crashes don’t happen close enough to each other to keep the emotional impact of the experience forefront in their minds.

“Of what use to make heroic vows of amendment if the same old lawbreaker is to keep them?” 

Ralph Waldo Emerson

Here’s the point of my message: You can’t change your habits unless you change the lawbreaker. Will you take note from historic market patterns and/or your own past errors –and learn from them? Or do you believe that this time is different? Are you the same old lawbreaker?

Take a look at the chart below. It’s the history of the S&P 500 from 1980, courtesy of the historic chart gallery on stockcharts.com. I’ve drawn some channels on the chart to illustrate periods of low volatility and high volatility. The black channels are normal/high volatility trends. They illustrate that markets climb a wall of worry. Lots of steps up/down as the market advances.

The pink trend channels illustrate periods of low volatility. These periods, as you will see in the bullet points below, represent about 2-3 years of market movement. They have, in every case, led into a period of correction, consolidation, or crash. Markets do not project upwards and onwards in a straight line forever. The lack of volatility is self-corrected via a period of high volatility. Every time.  Here are the periods of low volatility rapidly rising markets (illustrated by the pink trend channels). Note the corrections, consolidations, and crashes that followed each of them:

  • 1991 to 1994
  • 1995 to 1998
  • 2004 to 2007
  • 2013 to 2015
  • 2016 to 2018

As you will see by the outright lack of corrections over the past year, we are not only in a period of low volatility. We are in an historic period of almost NO volatility!!! It is my strong opinion that we will – sooner rather than later – enter into a period of volatility. Markets must self-correct excessiveness. That may mean a choppy consolidation. It may mean a simple but reasonably deep correction (10%-20%). Or it may mean a crash. That volatility may begin in January. Or it may begin in June. Or in a year. But it won’t begin in 5 years. That’s for sure.

 

Keith’s Off topic Rant coming this Thursday Dec. 21st

Every year around the Christmas holidays, I write a blog that is either philosophical, general musings, or political. I’ve written a piece this year that – in showing it to a couple of friends – has been noted as one of my better off topic rants.

It’s not on the topic of investing. So readers who prefer to focus strictly on my technical work can choose to avoid reading Thursdays blog. However, for those who enjoy these yearly outbursts, I hope you enjoy it.

2 Comments

  • What does a person do who has good position sizes in banks, pipelines, and gold? Do you continue to hold and collect good income? Perhaps add to positions on dips? Would you pare back on some positions? With a decent position in cash, does a person wait until technicals break? Thanks.

    Reply
    • That’s a pretty defensive portfolio John. I’m holding a bit of cash as noted, and if there is any dip in the next few weeks I will add new stocks to the portfolio. My thoughts are that the market will eventually show volatility and take out its excess, but I am not going to predict the date that volatility starts. In other words, business as usual until one of my larger sell rules as applied to the S&P 500 kicks in. Specifically, if the market takes out its 200 day (40 week ) SMA AND puts in a lower low on the weekly chart. Then I will reduce my equities. Not until then.

      Reply

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