I have a long history of watching bears destroy their wealth (and that of others) by living in fear of the next market meltdown. I used to work closely with an associate who felt it was his job to warn you about the next correction in stocks. In fact, this person was so wholeheartedly committed to pushing his agenda that he was able to convince many investors that he knew what the future held for stocks, bonds and commodities.
He must have had some sort of crystal ball under his desk that no one else knew about.
The most egregious error was not convincing people that a correction was going to materialize. Everyone knows that the stock market ebbs and flows just like the tides. We are going to experience periods of economic expansion and contraction, that is a part of every business cycle.
So, knowing that bears in general can be harmful to your financial health, here are a few things about them you should understand:
#1: Never Wrong, Just Early
The first thing you have to realize about bears is that they’re never wrong. They simply are early to a notion that the rest of the world has yet to realize. Whether it’s the next bubble that’s about to burst or a correlation to 1929′s Great Depression, the bears are always able to find a crisis that has yet to materialize.
If the market ignores their conviction and continues higher, they simply chalk it up to irrational exuberance of the masses and go into hibernation for a short period. Then when an opportunity presents itself, they trot back out the same arguments and try to convince you that the top is in.
I have watched bears call for a pullback over the last 100 points in the SPDR S&P 500 ETF (SPY). From a low of $125 in 2011 to a high of $185 in 2013 is a gain of 48% in SPY. Many bears have completely ignored this rally and have been left in the dust in terms of relative performance to the broader market.
However, I can pretty much guarantee that when we do see a 10% to 15% dip in the markets that they are going to tell everyone “they called it.”
2. No White Flag When the Selling Is Over
One thing I have always noticed is that when the market goes down 10%, it looks like it’s going to go down another 10%. That’s just the emotional nature of watching the market fall and living in fear that it is going to continue its descent. The psychological circle of panic and greed can be vicious.
Just remember back in 2009 when the market had already dropped 40% from high to low and everyone felt it was probably going down even further? Then quantitative easing kicked in, the selling stopped and stocks rocketed higher. No one raised a white flag and said the coast is clear. You just had to either be in stocks or you got quickly left behind.
That’s why it is so hard for bears to get back into the market to realize the upside. They feed on the fear that drives their ego and allows them to thrive when stocks are falling. They are finally on the right side of the trade, and no one is going to take that satisfaction away from them.
Until the buyers step in, that is.
I have only heard of a few rare exceptions of investors that have successfully navigated both bull and bear markets to capture profits in both directions.
#3: They Have a Lot More Conviction Than Discipline
Most bears are unable to cope with the concept that price is the ultimate arbiter of reality. They feel that any gains in stocks are unrealized and that ultimately those who are long are going to pay the price.
However, if they aren’t going to capture any of the gains on the upside, what makes you think they are going to call the top and get short in the sweet spot on the downside?
In my experience, bears are battling the market when it’s rising and they are late to the party when it’s falling. They lack the discipline to be steady traders because of their one-sided bias. Often times they override any risk management discipline because they feel that they know more than the market. That combination of conviction over discipline can be very dangerous to your wealth.
The Bottom Line
In my experience as a professional investor, I have come across many bears who are better marketers than they are long-term investors. Fear is a powerful motivator, and they know how to push all the right buttons.
Many people make a great living by trading stocks on the long and short sides of the market. I am not trying to discount the notion that you can’t make money when stocks are falling. However, you have to have the time, tools and discipline to be able to successfully implement trading strategies that work when stocks are falling.
Most traders would also tell you that they trade smaller and tighter when they are short vs. when they are long. That is because they know that at the end of the day they are fighting the natural inclination of the market, which can quickly bite them if they are not careful.
As an active portfolio manager, my preferred method of dealing with market volatility is through the use of stop-losses and tactical asset allocation strategies to defend my client’s capital. I don’t try to call tops or have a strong conviction about the direction of the market. I simply follow my trading discipline and watch trends develop.
It’s not a perfect system, and I have made my share of mistakes, but I am able to see both sides of the market and adapt when changes are necessary.
By staying balanced with my portfolio, I find that I am able to sleep better at night knowing that I am prepared for a number of outcomes. Markets aren’t always logical, but they offer us numerous opportunities for rewards if you are committed to a successful outcome.
Concerned about the risk within your portfolio? Contact us for a free, no-obligation risk assessment of every one of your existing holdings. We will work with you to formulate an individualized game plan for your assets.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. To get more investor insights from FMD Capital, visit their blog.