Stock market bulls – It’s your turn

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That’s it – the timely signal that people say “never” rings. You know – the announcement that the stock market is at rock bottom, so “Buy!”

Disclosure: The author is fully invested in actively managed US equity funds

Why the silence at such an important moment? Because lows occur when there is widespread negativity (AKA, popular) accompanied by dire predictions of the worst to come. Search “stock market” now and today’s torrent of pessimism is evident. So the environment is one of the leapfrog negatives. Positive? Of no interest. But there is more to this lack of optimism…

During these times, professional investors (whose careers are based on performance) are rarely, if ever, heard from. Instead, they focus on exploiting buying opportunities as they compete with other professional investors. Giving random investors free information defeats their purpose.

A good example is in early 2020, when Covid-19 risk first hit the stock market.

Throughout 2019 and early 2020, the stock market was on the rise. On a small dip, I wrote this positive piece (January 31):

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In this rising market, there was a healthy and balanced flow of bullish and bearish items as the market rose. However, two weeks later, something happened that I had never seen before – the bearish items suddenly disappeared. There was no obvious cause, so I assumed the fund managers had decided to sell and stop giving interviews. Therefore, I sold everything and published this article on February 16.

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This chart shows the movements of the Dow Jones Industrial Average over this period.

A word on stock market timing

The standard advice is not to. The assumption is that investors trying to miss out by buying and selling too late. This is certainly what happens if an investor follows media reports and popular trends (while relying on their feelings about stocks).

But there is another problem. No one can determine in advance the fundamental reasons and the reactions of investors for all (or several or some or even a few) major market fluctuations. We regularly read: “The investor who called the [fill in the blank] say now [whatever]. “The fundamental/investor issues underlying each major period are unique. Therefore, past success is irrelevant because the rationale applied for a period is not self-perpetuating.

Using my example above, I clearly had no idea about Covid-19 worries about to slam the market and investors’ psyches – neither about oil breaking below $0 – nor about a series of d margin calls at rock bottom. Instead, I relied on reading a contrarian indicator.

Contrarian investing can work because there are certain common characteristics that accompany dramatic trend changes. They do not identify the causes, but they can signal unbearable excesses. Excessive optimism (modes) and excessive pessimism (dreads) are reliable indicators of market ups and downs. Both can apply to the entire stock market and any of its components or investment themes. And this is where contrarian investing can really pay off. Don’t call it market timing. Instead, think of it as an opportunistic time, where potential return and risk are “optimized”.

The Bottom Line: “Optimise” Today Means Owning Actively Managed Equity Funds

Picking stocks can be rewarding and fun. However, the period we have entered has unusual characteristics compared to previous periods of growth and bull markets. Therefore, selecting a diverse group of fund management professionals, each following a different approach, appears to be the best investment strategy – at least at the initial stage. Picking a particular situation here and there is certainly acceptable, but gaining intellectual power, experience and breadth of research should optimize the risk/reward characteristics – and result in better sleep.

One more thing about actively managed funds. They are currently very much in the minority, with investors convinced that passive index funds with low fees are always winners. The changing environment we are going through, where selectivity is key, could cause a dramatic reversal. If this is the case, as has happened in the past when investors move from liabilities to assets, stocks held by active managers will benefit from the positive cash flow. Naturally, this improves the performance of actively managed funds – and so on.

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