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If This Is A Stock Market Bubble, It Should Be Ashamed

MIchael Batnick, 2017 stock market

With Michael Batnick, Director of Research at Ritholtz Wealth Management and writer of the blog Theirrelevantinvestor.com

Looking Ahead to the 2017 Stock Market: Are We in a Bubble?

In my end of year interview with wealth management Director of Research Michael Batnick, we wrap up 2016 by reviewing market movements and looking at winning and losing strategies during this year as well as over longer term bull and bear market cycles.  Wondering where the stock market is going in 2017?   With the bullish trend that’s been building steam since this summer—and has really taken off in the past six weeks—are we entering “bubble territory”?  If so, is it a bubble that has spread wealth throughout markets and the economy, or is it, in fact, a bubble that “should be ashamed of itself” as Steve terms it, meaning one that so far has only had limited benefits to the upside, and perhaps ought not to be trusted.   Michael’s thoughts on these subjects might surprise you, as even a veteran investor such as he admits that when it comes to timing the market’s ups and downs, the unknown factors greatly outweigh the known.

Don’t Be a “2% Investor”

One major takeaway from this conversation concerns the riskiness and overall poor performance of non-professionals attempting to “play the market.”  Michael refers to these do-it-yourselfers as “2% investors” because their average returns over time rarely provide more than a rather anemic 2% return.  The psychology behind the impulse to beat the steady-but-not-spectacular returns provided by managed funds (like mutual funds) is a powerful one, but those that follow it usually find the results disappointing at best.

They say hindsight is 20/20, and along those lines, markets can appear more rational or predictable than they really are when looking backward.  The temptation to get in and out of the market, making money and protecting gains by simply following significant trends up or down, seems logical in theory, but in practice, there is a lot of guesswork involved.  Timing even major market changes is far trickier than it might appear to the average observer.

As Michael points out, correctly identifying a true bear market is quite difficult in and of itself.  Even when markets shed 10% or more of their value, in the majority of these cases a -30% or -40% bear market does not ensue.  If you’ve pulled the trigger to sell after a 10% correction, you may be leaving a lot of potential gains on the table.  And for folks who think that selling some or all of their stocks while they are at all-time highs—as they are now, for example—again with the hope of getting a jump on the rest of the market and cashing in capital gains, Michael reminds us that in the history of the stock markets, all-time highs have followed one after another, more or less permanently raising the value of the market over the long haul.  Not only that, but selling stocks means losing out on dividends, and the rewards of buying new stock with those dividends.  The 2017 stock market may or may not continue the bullish trends of the latter part of 2016, but one thing that’s certain is that most short-term investors, whether selling or buying, are going to guess wrong on the timing.  It’s really just a question of how off was their timing, and how much that cost them.

Alternatives to Playing the Stock Market in 2017

Michael suggests that picking and timing stocks are, at the end of the day, a fool’s errand for most individual investors.  And while for the moment, most indicators seem to be signaling continued gains in the 2017 stock market, if you’ve got a disproportionate amount of your portfolio invested in stocks, you are exposed to a higher level of risk than is appropriate for most people.  As difficult as it might be to restrain the urge to make the most of the stock market’s rise by doubling down, the vast majority of individual investors should follow the best practices of an “asset allocation model” that manages risks and protects gains.  Your financial advisor can help you put together a portfolio based on this strategy and before you know it, you’ll be enjoying the absence of anxiety about market fluctuations.

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

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Steve Pomeranz: So many people walk into my office for help with portfolios they’ve been managing themselves, and most of the time I see a disorganized mess of too many securities, lots of trading, and no measurement of how they’re doing.  It’s what my wife used to call the cat’s breakfast when I look at their portfolios.  It’s just all over the place.  They just know that what they thought was going to be an easy process of managing money themselves turns out not to be.  Of course, it turns out not to be because if it was easy everybody would be successful at it.  It would be easy to be rich and, of course, it’s not.

Michael Batnick, Director of Research at Ritholtz Wealth Management, has written about this, so I asked him to join me today.  Hey, Michael,  welcome back.

Michael Batnick: Thanks for having me back, Steve.

Steve Pomeranz: You call the people that trade a lot and kind of time the market, you call them the 2% investors.  Why is that?

Michael Batnick: That sounds pretty condescending, but it’s not meant to be.  I speak to a lot of prospects and a lot of clients and, the more I do, the more I’m convinced that the majority of investors are what I call 2% investors meaning that over the course of their lifetime, they’ll have some good investments, they’ll have some bad investments, and they’re going to come away with a 2% return compounded.  Of course, the main culprit, the reason why they only earn 2% is because they buy at the wrong time; they sell at the wrong time, and they do it consistently over and over and over throughout their investing career.

Steve Pomeranz: We say buy high, sell low, repeat until broke.  That’s how we characterize it.  Go ahead.

Michael Batnick: Yes.  That’s exactly right.  These people tend to check their account balances way more frequently than they should.  They read the newspaper.  They think that they know something and they drape themselves with the illusion of control, where…”if I could only do this and that.”  We fail to see just how vast the financial markets are.  One of the great things about recognizing that you are a 2% investor and taking your finger off the trigger is that the market always provides a lesson—always!  Every year or every month you look at the market and say, “Wow, if I was trading or being more active, I would be getting demolished.”

You think about how 2016 got off to the worst start of any year that we’ve ever seen.  Some of the fears at the time, to be honest, it was so long ago I don’t even remember what it was.  I think what was driving it was the “earnings recession” coming up.

Michael Batnick: In particular, small cap stocks and the reason why they were getting hammered so much harder than large cap stocks, I’m not exactly quite sure, but it doesn’t really matter because, 10, 11 months later, small cap stocks are up 43%, energy stocks are up 46%,  financials up 40%.  Why are they up 40%?  Again, I don’t know.  The thing is, if you didn’t sell, you don’t have to worry why they’re up 40%.  You can just say, “There’s a lot going on, a lot of variables;  I can’t put it all together, and I don’t have to.”

Steve Pomeranz: Wait, but the psychology that someone experiences when the market is down.  The market is down 10%.  If the market goes down by 30% I am going to be so happy that I got out at 10%.  I’m going to feel smart like I made the right thing.  Since the future cannot be foretold, there have been periods of time when getting out when the market was just 10% down would have seemed like a brilliant move.  Pick 2008 as an example.

Michael Batnick: Absolutely, but the problem is how many false positives would you have reacted to because every 10% correction does not lead to a 20, 30, 40% bear market.  I’ve actually written about that before.  What happens if you knew for sure, if God tapped you on the shoulder and said, “Hey, I’m letting you know a little secret.  We’re about to experience a bear market.” You got out and then you waited back to even when you got it.  You still came out behind because what nobody thinks about and factors into the equation are dividends, dividends being reinvested at lower prices.  That makes a humongous difference.

Steve Pomeranz: The bottom line is nobody really knows what the market is going to do.  Back in February, March, there was the Brexit worry.  I actually thought, of all the worries that we’ve been through—the fiscal cliff and the government not paying its bills and so on and so forth—I thought Brexit seems really, really important because you’ve got a country actually breaking out of an economic union.  Of course, being a veteran and investing, I didn’t do anything.  I waited it through to see what would happen.  The market basically rallied after Brexit.  With the Trump election, same thing.  Everybody thought the market was going to tank and the market has gone straight up.  Timing is impossible.

We understand this idea of not timing the market, but now every day in the news we hear that the U.S.  Stock Market is hitting new highs and the biggest reaction that I hear from the people that I work with, clients and the like, is “is the market too high?”  I don’t want to buy here.  I’m afraid to buy here.  My answer is it may be high, but that’s a good thing.  When I entered into the investment business, it was 1981; the Dow Jones was at 1,000 and then it was at 2,000 and then it was at 5,000.  Those were highs.  Now it’s at 19,000.  It’s never going back to 1,000 or 5,000.  Those highs are basically bolstered by the fact that corporations making up these markets are actually worth more today than they were 20 years ago, but Mike, let me put the point on you.  We are at a high in the marketplace.  What do you say about investing now?

Michael Batnick: A few things.  The natural inclination at all-time highs is either to take some chips off the table or, if, unfortunately, you’re holding too much cash, “I can’t put it to work now because it’s just my luck that I’m going to invest and the market’s going to tank.”  As if it were that easy.  All- time highs, stating the obvious, are not a bearish characteristic—  they’re the exact opposite.  What you would expect to see in a bull market is new all-time highs.  One after the other after the other.

You have to caveat this and say, obviously, it’s true that the worst bear markets every, the Great Depression, the ’70s, 2000, 2008, of course, they happen after all-time highs.  However, I don’t remember what the number is, but there are over 1,000 all-time highs.  They are a constant.

The idea, putting it to this current market environment, that you’re not going to buy stocks because they’re at all-time highs, and we’ve [inaudible 00:08:25].  We’re pulling forward future returns.  I will remind you that stocks are up.  The S&P 500 is up 4% over the last year and a half.  Yes, it’s up a lot since November 8th, but [inaudible 00:08:38].  Taking even a further step back, over the last 16 years, stocks are up 3 1/2% per year.  This could just be starting.  People might measure, we’re in the seven-year bull market, as if March 6, 2009, was the day the bull market started.  That’s absurd.  If anything I would argue that the bull market started in 2013 when we peaked out of our 2000 and 2008.

Also, and maybe I’m getting away from the point, but also we did have a 21% “bear market” to reset the clock in 2011.  I don’t know what chart or what number people are looking at when they talk about the length of this current bear market.

Steve Pomeranz: I think you make a really good point.  For the last two years or so the U.S. stock market has been basically flat with a lot of volatility.  It’s been kind of the worst of both words.  You’ve experienced a lot of volatility which you accept in the hope that you’ll earn a good, solid rate of return, and, yet your rate of return was basically flat.  A lot of frustration.

Michael Batnick: I joked the other day that this is the worst bubble I’ve ever seen.

Steve Pomeranz: This bubble should be ashamed of itself, right?

Michael Batnick: Exactly.

Steve Pomeranz: Now that the market is starting to increase, and, it looks like on the surface—for valid reasons—it looks like the economy is really picking up a little bit.  Interest rates are rising to reflect that.  There is the promise of Trump’s tax cuts and, so on, which is just promise at this point, and do due regulation and things like that.  There just seems to be a sense, maybe, that the animal spirits are starting to be aroused once again.  It’s very possible that 2017 could turn into a pretty good year.  Final words?

Michael Batnick: Yes.  Sure.  We’re up around 8% this year which is pretty funny considering that we’re in a “low return environment.” Yes, 2017 could be a great year.  Maybe.  Maybe not.  I have no idea.  Don’t care.  The final point that I’d like to make—and this is really, really important—is that when you are making these sort of decisions to get out on February 11th at the lowest and get back in when the dust has settled, and you get out and you get in and you get out and you get in, what happens is that you’re building up all sort of mental scar tissue in your brain.  Your future decisions are not going to made in a vacuum.  You’re going to say, “Well, last time I sold and I was wrong, so, maybe this time, I won’t sell and maybe I’ll be right.” Rinse and repeat and you do the same thing over and over and you’ll always anchor to your most recent mistake.

That is why it’s so powerful to just say, “I don’t know where stocks are going to go.  I’m going to put together a proper asset allocation model that I can stick with through thick and thin.”  Guess what?  If that asset allocation model includes 25, 30% cash because you know you’re a nervous Nelly?  Fine.  There’s no one way to do it, but just build something that you are comfortable with when markets are screaming to the upside and crapping to the downside.

Steve Pomeranz: Very good. My guest, Michael Batnick, Director of Research at Ritholtz Wealth Management.  To hear this interview again you can go to stevepomeranz.com.  That’s P-O-M-E-R-A-N-Z.  Stevepomeranz.com.  Thank you, Michael.

Michael Batnick: Thank you.