The Market is Always Right?
“The Market is always right.”
One of the most popular sayings in markets and also one of the most dangerous for investors. Why? Because the “market” can be very, very wrong – often at the worst possible time.
A few examples in history when we were told: “the Market is always right.”
1) Nikkei peak in December 1989. A 79% decline would follow. Over 26 years later, it is still 44% below that peak.
2) S&P Tech Sector peak in March 2000. An 82% decline would follow. Over 15 years later: still 25% below that peak.
3) The peak in US Home Prices in July 2006. They had doubled since 2000. Over the next six years they would fall 35%. Today, ten years later, prices are still 12% below the 2006 peak.
4) Athens Stock Exchange Index (Greece) in November 2007. It had quadrupled in the previous four years. Today: 89% below that peak.
5) Silver in January 1980. It had increased by over 1000% in the previous three years. Less than two years later it lost 90% of its value. Today: 70% below the 1980 peak.
6) High Yield Bonds in December 2008. They were yielding over 22%, pricing in another Great Depression. Less than a year later, they had recouped all of their losses.
7) From 1991 through 1997, Apple Computer dropped 80%. It did so again from 2000 through 2003. Then, from the 2003 low, it advanced over 14,000%. $1 in 2003 was worth $150 in mid 2015.
8) Interest Rates in 1981. Mortgages were above 18% while 30-year Treasury Bonds yielded more than 15%. Over the next 35 years, rates would fall.
9) Arch Coal in early 2011. Over the next four years, the equity and bondholders would lose over 99% of their value. The company filed for bankruptcy in January of this year.
10) Fed Funds Futures, any year since 2009. The market has become obsessed with these market expectations for Federal Reserve Policy. Their accuracy? In 2009-11, they were anticipating rate hikes off of 0% in each of those years. The Fed did not hike until December 2015. The predicted path from 2012-15 has proven to be overly hawkish as well. Today the market is not projecting a hike until 2018.
11) Crude Oil Futures were predicting Oil to be over $100 in February 2016. The price today: $28.
From these examples it should be abundantly clear that the market can be very wrong at times, often at key inflection points. But just because the market is not always right (is not entirely efficient) doesn’t mean it is easy to beat. Far from it. But it does mean it is possible to enhance returns or reduce risk by practicing a version of what Michael Steinhardt called “variant perception.” This is the idea that returns can be generated by taking a differentiated or contrarian view that had yet to be appreciated by the market.
Invariably, the best risk/reward opportunities in history occur when the market is wrong. This often occurs when investors are irrationally exuberant or irrationally despondent about the future due to recent price behavior. The difficulty in moving against this prevailing sentiment cannot be overstated. Those who read or watched “The Big Short” understand the challenge in going against the herd in the housing bubble mania. They knew the housing market was not right in 2006 but they had to stay in business long enough to capitalize on that view. They did in the end but not before many sleepless nights.
For investors who maintain a diversified portfolio of various asset classes, rebalancing back to target weights when a large deviation occurs is a mechanical way to practice variant perception. By moving moving from “what’s working” (tech stocks) to “what’s broken” (bonds or value stocks) after 1999 was certainly not easy, but proved to be fruitful in the years ahead.
What about the market today? Do any variant perception opportunities exist? There are a few areas that should come to mind.
What are the pundits saying about these potential mispricings? You guessed it: “Nothing to see here. The Market is always right.”
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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
CHARLIE BILELLO, CMT
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of three award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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