What Is a Bull Market? No Darn Good!

What Is a Bull Market?: Beef #1 — The expected long-term return on stocks heads steadily downward during a bull market.

When stocks are at moderate valuation levels, the expected 10-year real return is in excess of 6 percent. At the top of the recent bubble, the expected 10-year real return dropped to a negative 1 percent. I’d rather have a whole bunch of years in which I earn a real return of 6 percent or 7 percent than have a few years in which I earn 20 percent or 25 percent followed by a long string of years in which stocks provide mediocre returns or even negative returns.

Pride Comes Before a Stock Crash

What Is a Bull Market?: Beef #2 — It is bull markets that make bear markets an economic necessity.

Most people love bull markets and hate bear markets. For obvious reasons. The reality, though, is that bears are just the mirror image of bulls. Prices need to go down dramatically to make up for times when they go up dramatically. Do away with bulls, and you would be doing away with bears too. If you hate bears, you should also hate bulls.

What Is a Bull Market?: Beef #3 — Young investors are unfairly penalized by bull markets.

Lots of people got rich during the recent bull, which appears to have come to an end in January 2000 (this article was written in August 2006). But most investors now under the age of 30 have not yet had a chance to earn exciting returns with stocks. It’s the hangover from the recent bull market that makes stock investing so dubious a value proposition today. Bull markets cause stock returns to be distributed in ways that unfairly favor people born at the right time to take advantage of the boom years.

What Is a Bull Market?: Beef #4 — It becomes impossible to talk straight about the realities of investing during bull markets.

There have been many exciting discoveries in recent years about how stocks really work and about how best to invest for long-term success. Many investors have been too caught up in the emotion of the bull to learn about these discoveries. The emotionalism characteristic of bulls hinders the efforts of middle-class investors to learn what they need to learn to attain financial freedom early in life.

What Is a Bull Market?: Beef #5 — Investors don’t need bull markets to earn an outstanding return from stocks.

The long-term annualized real return for U.S. stocks is 6.8 percent. That should be good enough for reasonable investors. To demand more is to fall victim to greed.

What Is a Bull Market?: Beef #6 — The devastating losses suffered by many investors at the end of bull markets causes them to swear off of stocks forever.

Bull Markets Make Us Look Like Fools

Greed always turns to fear. During bulls, many investors laugh at people who keep their money buried in their back yard or invested in the safest of asset classes. When they get wiped out in the wild bears that always follow wild bulls, they end up adopting the very practices they once laughed at. I’d rather earn strong returns from stocks for many years than earn too-good-to-be-true returns for a few years and then abandon the asset class because I wasn’t able to handle the rocky ride it delivers in a bull and in its aftermath.

What Is a Bull Market?: Beef #7 — Bull markets make it exceedingly difficult for those invested in stocks to plan their financial futures.

What’s you net worth today? You need to know to be able to plan effectively. But how can you calculate the value of your stock portfolio when the price reported in the newspaper is twice the price that would apply if stocks were at reasonable valuations? I’d rather know that my wealth is smaller and have the number be one that I can count on than be taken in by the fairy-tale promises of the newspaper prices we see at the tail-end of wild bulls.

What Is a Bull Market?: Beef #8 — Bull markets highlight the emotional side of the stock investing experience.

I love stocks because I love financial freedom and stocks play a big role in my plan to win more of it. I don’t at all like the ugly emotions that evidence themselves at the tops of wild bulls. Fear? Yuck. Greed? Yuck. Anger? Yuck. False pride? Yuck. When an investment class causes you to become a less likeable person, it’s time to move some money into other investment classes.

What Is a Bull Market?: Beef #9 — Bull markets make stock investing a gamble.

My Beef With Bull Markets

The 6.8 percent annualized real return for stocks is pretty much a sure thing. That number has held for many, many years. So it’s not really true that stocks are a risky investment class. Risk becomes a serious concern only when stocks earn a return far above 6.8 percent over an extended time-period. Stocks have earned a reputation as a risky asset class because of the way they behave in the aftermath of wild bull markets.

What Is a Bull Market?: Beef #10 — Many people are fooled by bull markets.

People say foolish things during bulls. Even experts do. Bulls reveal the dark, small, foolish side of human nature. I like to think that we are smarter and better and stronger than what we appear to be during bulls.

Cliff Asness explains how bull markets make fools of us all in his article entitled “Bubble Logic.” 

What Is a Bull Market? Beef # 11 — Many investing advisors feel compelled to compromise their integrity during bull markets.

Bulls couldn’t take place if investing advisors talked straight about how risky stocks become when prices get out of control. Some do tell the straight story and I view those in that group as heroes. Many get carried away in the bull euphoria or fail to speak out in clear and direct terms against it. Those who lack the courage to tell people what they need to hear rather than what they want to hear are failing to do their jobs. It is the pervasiveness of the bull market psychology that causes them to compromise themselves in that way.

What Is a Bull Market?: Beef #12 — Bull-market prices put retirements at risk of going bust.

We are likely to see millions of busted retirements in days to come because of retirees who put their confidence in today’s retirement planning tools, which are marred by their reliance on bull-market “logic.” There’s never been a more dangerous time to retire than at the top of the recent bull, in early 2000.

What Is a Bull Market?: Beef #13 — Bull markets cause investors to overlook the merits of alternative asset classes.

Non-stock investment classes often need to offer mouth-watering returns to attract investor attention at the tops of wild bulls. In January 2000, when the safe withdrawal rate for stocks was down to 1.6 percent, the safe withdrawal rate for Treasury Inflation Protected Securities (TIPS) was 5.8 percent. Investors had a once-in-a-lifetime opportunity to lock in a guaranteed 30-year return of 4 percent real from TIPS at that time. But at the time you couldn’t get people to stop talking about stocks long enough to take a look at TIPS.

What Is a Bull Market?: Beef #14 — Bull markets get investors in the habit of expecting “magical” investing results.

Humans are creatures of habit. We learn most of what we come to know not from reading words in books, but through personal experience. The lesson taught by wild bulls is that prudence is for losers and that investment returns far in excess of those that are justified by the economic realities are easy to obtain for those “smart” enough to throw all their money into stocks. Bulls teach all the wrong lessons.

What Is a Bull Market?: Beef #15 — Bull markets cause investors to underestimate the long-term effect of suffering big drops in portfolio value.

Insane Stock Prices

During bulls, price drops are short-lived. We learn through experience to buy on the dips. Then we experience the long-term dip called “a bear market.” Most of us are caught unaware. It is the trickery of the bull that causes us to lose our natural caution about putting our hard-earned savings at risk. Bulls cause us to suffer devastating life setbacks that some of us do not recover from for decades.

What Is a Bull Market?: Beef #16 — Bull markets make buy-and-hold investing more difficult than it would otherwise be.

Buy-and-hold is the way to go. Most investing advisors agree. But it is extremely hard to develop the skills needed to become a true buy-and-hold investor during a bull. There are no real tests of the buy-and-hold strategy during a wild bull. Trying to learn how to be a buy-and-hold investor during a bull is like trying to learn how to run a marathon by watching one on television.

What Is a Bull Market?: Beef #17 — Bull markets can keep valuation-informed investors out of stocks for a long time.

I sold my stocks in 1996, when we first went to a P/E10 level of 26. That’s a red-alert level of overvaluation. We’ve had a few ups and downs since then, but we are still at a P/E10 level of close to 26 today. So it’s been 10 years since I and other valuation-informed investors have been able to participate to the extent we would like in the stock market. Bulls take too long to die. Watching the slow death of a major bull is a stone cold drag.

What Is a Bull Market?: Beef #18 — Middle-class investors would earn higher returns if there were no bull markets.

Middle-class participation in the stock market goes up dramatically when stock prices are high, and then down dramatically when stock prices are low. That means that most middle-class investors are not enjoying those juicy 6.8 percent long-term returns that stocks earn on average. We get in at the wrong time and we get out at the wrong time. It would be a lot easier to know when to get in and when to get out if we didn’t have the illusions of bulls causing us to act contrary to our self-interests.

What Is a Bull Market?: Beef #19 — Bull markets are emotionally exhausting.

Rising Stock Prices Signal Trouble Ahead

Prices climb a wall of worry in the early years of a bull. The worries only get greater in the late stages of a bull because that is when most investors have the most at risk. Like Carly Simon, I haven’t got time for the pain. I lower my stock allocation when prices get out of control and increase it again only when stock prices return to reasonable levels. Stocks are great when the price at which they are being sold makes sense. I question whether they are worth the emotional strain when you need to send your rationalization efforts into overdrive to justify holding on a bit longer.

What Is a Bull Market?: Beef #20 — Bull markets always end badly.

Watching a bull market unfold is a bit like watching a performance of a Shakespearean tragedy. There are sure to be lots of long speeches explaining what’s going on and probably a bit of tomfoolery for comic relief and perhaps one or two unexpected plot twists. The image on your mind as you leave the theater, though, is going to be the blood and the numerous dead bodies covering the stage in the final scene.