Can anything stop this bull market? Seemingly ever fewer investors think so. The unadulterated panic ruling markets last February and March seems ancient, with increasingly optimistic pundits seeing gains ahead. That view seems justified. But its rapid spread symbolizes a warning: Just as you had to conquer your emotions to reap this nine-month-old bull market’s gains to date, you now must keep emotion at bay—just a different one. Failing at that risks falling prey to the market’s next trick: getting fooled by greed. Here’s why.
Investment legend Sir John Templeton famously said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” We’ve seen that pattern evolve quickly since last winter. After the coronavirus’s spread sparked unprecedented economic lockdowns, panic reigned. From mid-February to mid-March, the percentage of bearish individual investors tabulated by the American Association of Individual Investors (AAII) nearly doubled. It also showed bulls went from outnumbering bears by 14 points in mid-February to bears outnumbering bulls by 29 points in late May, during this bull market’s pessimistic phase. Fund managers’ collective equity allocation plunged in March and again in April, sinking to its lowest level since March 2009. Managers’ cash balances surged to their highest level since the 9/11 attacks. All backwards in retrospect.
Panic eventually waned, but pervasive pessimism and skepticism remained. Pundits called stocks’ upturn a short-term central bank sugar high—disconnected from the horrors then surrounding us. Massive “stimulus” efforts would only lead to longer-term trouble, they said, also warning any COVID resurgences could quickly squash the rally. Investors broadly pulled money from equity funds—even as stocks reached record highs.
But since November, positive vaccine news and election clarity sparked optimism. Forecasts for 2021 are near-uniformly bullish. Investors are reinvesting back into stock funds. AII surveys show bullishness surged in October and November. Signs of outright euphoria have started: Some big-name initial public offerings soared in December. Special purpose acquisition companies (SPACs)—blank-check firms that go public to acquire private companies, letting the latter bypass the burdensome IPO process—are dominating debuts. Pundits fawn over folks who built small fortunes with ultra-concentrated, high-flyer portfolios dangerously lacking in diversification. Sentiment is far from uniformly stretched—many doubters still pin stocks’ strength solely on the Fed and fiscal “stimulus”—but animal spirits are stirring.
Once sentiment starts warming, it tends to continue for a good while—implying greed and euphoria will perk in the not-so-distant future. As it does, remember: Most investors’ greatest enemy is themselves, as I detailed in August.
Then, I was referencing investors who allowed rampant, widely publicized fears to keep them from the market’s powerful rebound. Now, as optimism swells, you must keep another emotion in check: greed. Greed makes investors think they can make a quick buck with little risk. They chase heat—always dangerous. Or they ditch diversification and load up on a few high flyers. Long-term plans and memories of past bear markets fade away, replaced by get-rich-quick dreams and fear of missing out. But investing isn’t about easy money. It’s about building a comfortable financial future over time, harnessing the magic of compound growth to build wealth—without taking on unnecessary risk. It’s a long journey with minimal shortcuts.
The brightening mood means you must get vigilant—but doesn’t mean the end is nigh for the bull market. Stocks can rise for a long time once sentiment warms. Optimism arrived in the middle of the 1990s, but that bull market ran until March 2000. Often exceptional years come late as optimistic investors pay crazy-more for future earnings—US stocks soared 33.4%, 28.6% and 21.0% in 1997, 1998 and 1999, respectively.
Even euphoria isn’t an immediate bear market trigger. The 2000 – 2002 bear market didn’t arrive until many months after euphoria was prevalent. For a bull market to die, sentiment needs to reach the point where a near-term negative makes lofty expectations far from attainable. In 2000, Tech froth blinded people to an inverted yield curve driven by the Fed’s reaction to overheating. Most who saw it dismissed it as part of the “old economy.”
Today, surging sentiment merely supports my take that this is a late-stage bull market—contrary to what most believe. As I explained in September, most recessions are natural resets occurring when businesses work off excesses. But 2020’s downturn came when government shutdowns sent an otherwise healthy economy into contraction. Hence, stocks aren’t acting like they would early in a new cycle. Instead, it is as if this is year 12 of the bull market that began in March 2009. That bodes ill for the value stocks pundits hype for their historical early-cycle performance. Instead, it favors typical late-stage leaders, as I’ve said since the rally began—basically, growth stocks. You’ll find plenty in the Tech sector and among Tech-like Consumer Discretionary stocks. The Luxury Goods and Pharmaceuticals industry offer more.
Warren Buffett famously says investors should “be greedy when others are fearful and fearful when others are greedy.” The time to be fearful isn’t here yet—but it may come sooner than many believe. Be equitized, vigilant, patient and stay soberly level-headed. The time for bearishness is not too darned far ahead.