It looks like one of the longest bull markets in U.S. history has come to an end. A bull market is when stock prices are rising. Obviously, people love bull markets. It makes them richer. What could be better?
But it looks like we’ve entered a bear market. People hate bear markets. They lose money. Lots of money. At least on paper. A bear market is generally defined as one that experiences at least a 20 percent decline in stock prices. Some see larger losses — even up to 80 percent of the market’s value, which can be devastating to both individual and institutional investors alike.
There is no way of knowing how bad this bear market might turn out to be — until it’s over; until we can see it in the rearview mirror. Which makes investing hard.
In hindsight, it’s easy to see a bear coming. They’re preceded by abnormally high stock values. Often, they’re preceded by bubbles. That’s what happened with this last bull market. Valuations got ridiculous.
So why didn’t people sell? Why did they hold on to their stocks until the bear arrived and took his bite out of their portfolios? I’ll come back to that in a minute.
The last bubble involved real estate. It inflated 12-15 years ago. Valuations went off the chart. It was easy to see it was a bubble, yet people kept buying. At super high prices. Which tells us something about human nature — which is a term we use for mistakes that us humans make over and over again. It also reveals why people didn’t sell their stocks before this latest bear market began.
The answer isn’t hard to figure out. It’s because humans frequently make decisions based on beliefs, not information. We incorporate those beliefs into our stories and narratives. And then we use those stories to make decisions — decisions to do something or not do something. Even if the available facts suggest we should do otherwise.
Extrapolation plays a powerful role in the formation of those stories. We convince ourselves that current conditions and trends will continue into the future. Even if facts suggest otherwise.
Humans seem to have a hard time believing that conditions will change. And that reluctance is even more entrenched when we’re in a bull market and people are seeing their wealth increase. Who wouldn’t want that to continue?
It’s that desire that overwhelms reason. And makes us look foolish in hindsight.
Of course, even if we’re focused on the facts and not the narrative or wishful thinking, getting out before the bear arrives is no easy task. Bulls can run much longer than facts would suggest, which means there can be a high lost opportunity cost involved in turning tail and running too soon. All of this contributes to inertia.
Another force at play is the herd mentality. It’s more comfortable psychologically to run with the herd, even if the herd turns out to be wrong. I suppose it’s part of our human nature. Standing alone, or with few others, is uncomfortable. And, often, scary. So we tend to avoid that feeling. And stay with the herd. Even if the herd is heading to the cliff. And about to fall off.
There are lessons in all of this for us, Vera. All you have to do is observe. And study history.
Many people avoid history. To them, it’s boring. That’s a mistake. If we avoid learning from history, we’re destined to make the same mistakes. Over and over again, which, of course, is what we do. It makes no sense. Yet it’s real. Consider that.
Also consider whether you always want to run with the herd. And, if so, why? What does that tell us about ourselves? And how should we figure that into our decision-making?
If you find you’re too uncomfortable leaving the herd, ask yourself why. And what you should be doing to get comfortable, assuming, of course, you want to avoid the cliffs — that will always show up, to take its toll on the herd.
Avoiding the fate of the herd isn’t as easy as it might sound. Standing outside the herd can make you feel vulnerable. And entail certain other risks — or, rather, perceived risks. Maybe they exist only in our minds. But isn’t that where everything exists?
You also don’t want to succumb to the temptation of being a contrarian by nature, that is, someone who thinks it’s always best to remain outside the herd. That’s risky, because the herd is often right. At least to a point. The danger is not running with the herd; rather, it’s running with the herd when the herd has lost its mind and is failing to see the approaching cliff. That’s when it’s critically important to peel off.
One thing that’s essential if you are to be someone who resists the temptation of mindless extrapolation is confidence. You have to have it or you’ll never be able to avoid the cliffs. It will be too scary.
Fortunately, confidence is something you can develop. You’re smart enough. But it may not come naturally. It may require effort. And intentionality.
I found I had ample confidence in many things in the course of my life, but I lacked confidence in other key areas. Of course, you’ll never be confident in things outside your area of knowledge and expertise, and you can’t know or be good at everything. That’s not what I’m talking about. What I’m referring to is the lack of confidence in life. In the decisions all of us have to make.
To have such confidence, you need to be aware. And reflective. And constantly observe. And learn. From history. From the present. From others. From yourself.
And, above all, you need to be mindful of the difference between the stories — the narratives — and reality. There is always a gap. Sometimes the gaps are small. Oftentimes, they are huge.
Mind the gaps.
(P.S. Regarding the smaller issue pertaining to stocks, I realize, for tax and other reasons, some investors choose to buy and hold for the long term, weathering bear markets along the way, which often is the best strategy concerning their particular investment objectives and time horizon.)