Bull Markets are the Hardest Part

There are two difficult times to be an investor – when the market goes up and when it goes down.¹ We all know the difficulty of the bear market. It usually works something like this:

1. We think markets will go up for some reason.
2. Markets go down.
3. Markets go down a lot more than we’re comfortable with.
4. Soil shorts, reconsider how you’re allocating your assets and go change your pants.

Well, not exactly like that, but probably not too far off. But the harder type of market for many people to deal with is the bull market. Not because the bull market exposes you to a lot more stress or anything like that.  But because it’s during the bull market that we make the mistakes that make the bear market stressful (and yes, the bear market is always coming at some point).

Hyman Minsky famously said that the boom causes the bust when stability leads to instability. Similarly, it is during the seeming stability of the bull market that most people make portfolio mistakes. They chase performance, reallocate towards stocks, assume recent performance is perpetual, etc. This is the logical equivalent of removing your roof every time you go through a long period of sunshine. Then when it rains you’re changing both your pants AND your shirt!  But investors consistently do the same thing in the financial markets. It gets really sunny out for a long time so they overexpose themselves to the sun. And then when it rains they’re shocked that it could rain and aren’t prepared for the storm.

As the stock market approaches new all-time highs just remember that it’s during the boom that you most need to prepare for the bust. At the same time, this doesn’t mean that you should build a bunker that will completely protect you from the storm. You want SOME exposure to the sun knowing that it’s sunny more often than not. And in the same way that the sun facilitates the production of vitamin D we need, having exposure to growth assets is what facilitates the growth we need in our financial assets. But take this time to make sure that exposure still has a roof, is properly insured and hedged in a way that any eventual storm won’t blow you out of town pantless and shirtless.³

¹ – I guess, technically, the other hard time to be an investor is when the market moves sideways though, in reality, it really doesn’t spend much time doing this (except when it’s closed, which, technically means it isn’t operating, which, technically, means we shouldn’t count those times).²

² – I can’t think of any other technicalities here, but I am sure there are a few.    

³ – Soiled, of course.