With apologies to Charles Dickens, his novel about an English orphan who rises to wealth, deserts his friends, and ultimately becomes humbled by his hubris and arrogance might one day double as a plot summary for what has been going on in the bull market that started in late 2022.
Many otherwise-ordinary people have seen their wealth increase to previously unimagined levels owing to to the run-up of real estate prices, while showing blithe indifference to the rate hikes we’ve seen over the past 16 months or so. Stocks have done well over that time frame, too. Numerous polls have shown investor sentiment to be highly bullish.
That brings us to the principle of rational expectations – an economic theory that suggests individuals make decisions based on the best available information and learn from past trends. Rational expectations suggest that people will be wrong sometimes, but that, on average, they will more often be correct. To date, policy-makers and corporate executives have done a solid job in bringing inflation down, maintaining high employment levels and expanding the economy. To hear the industry tell it, it is entirely rational for that pattern to continue to be the case. Is it?
In other words, the real question is: Can it be rational to have irrationally great expectations? The behavioural finance concept of a “greater fool” suggests that it may be rational to buy assets that are expensive (i.e., to reject the adage of buy low; sell high) if you are confident there is a greater fool out there somewhere who will nonetheless buy your asset at a higher price still (buy high; sell higher). This trend can continue for a long time, but it cannot last indefinitely. To quote Keynes: “Markets can remain irrational longer than you can remain solvent.”
If we have learned anything from the great crashes of 1929, 2001 and 2008/09, it is that investors (often spurred by easy money in the form of low interest rates) can come to think of themselves as being invincible, much like Dickens’s protagonist Pip.
A good deal of personal finance is grounded in social psychology – especially group psychology. People can get ahead through investing not only by being shrewd about valuations and such, but also by accurately anticipating how other market participants might react to a given set of circumstances. Knowing full well that decision-making regarding future courses of action of disparate groups is a fool’s errand, people still play the game.
Walter Gretzky is said to have advised his son Wayne: “Skate to where the puck is going, not to where it is.” That thinking explains much of economic forecasting and personal investing. As long as markets continue to rise – and as long as people continue to expect them to rise – there’s often a handsome reward for having a bullish disposition. People will ride the bull and smugly think themselves to be shrewd for doing so. As such, it can be said that it is rational to have great expectations as long as a significant number of others share that viewpoint.
My concern is with the messaging being offered by the personal finance community these days. To hear many of them tell it, there’s no appreciable need to be concerned about high valuations, high debt levels (both public and private), an extremely inverted yield curve and interest rates at generational highs. Any one of these considerations would ordinarily give a rational investor pause. Taken together, they pose a clear and present danger for investors in the second half of 2023. Few seem concerned and it is that very lack of concern that concerns me.
Earlier this year, I released a book entitled Bullshift – How Optimism Bias Threatens Your Finances. In it, I explain that the investment industry’s perpetual bullishness is rooted in corporate profit motives rather than anything resembling a fiduciary mindset that focuses on retail investors. The industry shifts their clients’ attention away from legitimate risks that seem particularly pronounced in order to make them feel bullish. Being bullish is good for business and most of the time, things work out. But even if things work out fine 19 times out of 20 – and even if they don’t – there’s safety in numbers. (It’s difficult to argue there’s been corporate malfeasance if everyone else is offering a similar market outlook).
There’s a massive risk looming for investors who obediently buy in to the industry’s self-serving bullishness without stopping to think critically about what would ordinarily be seen as flashing warning signs. I have been an advisor for 30 years and I cannot think of a single instance where the industry consensus was to take a more defensive stance in light of empirical concerns. In my 30 years, I have never seen so many concerns converge in one market. It’s good (read: profitable) to be an optimist most of the time, but it’s better to be a realist. At least realists have a fighting chance of seeing past the bullshift.
John De Goey is a portfolio manager with Designed Securities Ltd. (DSL). DSL does not guarantee the accuracy or completeness of the information contained herein, nor does DSL assume any liability for any loss that may result from the reliance by any person upon any such information or opinions.
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