This bull market in U.S. stocks is now the longest, and by many measures the most hated in history. After almost quintupling since the global financial crisis of 2008, I look back and see an incredible rally that has never been totally convincing. Behind the bull market lurk apparent culprits such as “corporate buybacks,” “easy central banks,” “tax cuts,” “lax regulation,” “systematic strategies,” “passive investors,” “ETFs,” “king dollar,” and of course the more favorable “earnings revisions.” So let us not pass judgment on this bull. As a friend recently said: “Don’t do good or bad, do bullish or bearish.”
Defying all odds, a simple strategy has worked so far in this bull market: “buy the dip and hold.” Even after February’s 10% correction, the S&P 500 is up more than 9% this year. Other global markets have not done so well: emerging markets, have sunk close to 20% with no end in sight. Buying the dip there has obviously not been a good strategy for copycats in other markets. Frustrated money, like water, flows quickly through the biggest pipe to the biggest receptacle, and the one leading back to the U.S. from the rest of the world is the largest one out there.
The best strategy in hindsight has been to ride the U.S. stock market bull without being thrown off, while for emerging markets the secret has been to get off the bull early and stay off. Will this ride continue with U.S. equities at record highs? Does it make sense now to pivot and mount the emerging market bull?
The first rule, professional bull riders tell me, is to know the bull and be prepared for anything. To stay on the bull one has to get real familiar with the beast: “Before you get on the bull you need to know how to read that bull. Does it pull to the left, pull to the right, or pull straight up or down”?
In rodeo bull riding, the rules call for the rider to stay on the bucking, spinning, kicking bull for a total of eight of the “most dangerous seconds in sports.” The bull gets scored for the difficulty it offers, and the rider gets scored for staying on the bull.
Everyone likes a good game, and certainly the U.S. stock market bull gets a perfect score for giving us a great show so far, climbing worry after worry : Brexit, Elections, Tariffs, Sanctions, North Korea… For us riders there is still time to learn. Here are some general principles:
Fade the noise: This bull, it rallies hard on bad news, but as soon as the sentiment and news gets too good, it sells off to take the hot money off the market. Pundits have loved to call both tops and bottoms in this market, and everyone has become a market technician (alas, a favorite fundamental analyst recently sent me a piece that forecasts markets based on Japanese Ichimoku clouds!). By listening to the noise, it has been easy to miss the secular rally by getting in and out of the market frequently, which as we all know only creates churn and transactions costs. Many struggle to admit that they have fallen victim to this themselves when running different portfolios, including levered ones. Passive rightly has trounced active this time around.
Have a long horizon and hang on: In this bull market, the approach that has worked is to stay calm and hang on, which requires taking exactly the right amount of risk (discussed below). Taking the right amount of risk is a very hard job, especially when barraged by news all day and night. It is just human tendency to focus on the most recent news and react to it. Combine this with the disposition effect, i.e. the tendency to sell winners too early and ride losers too long and you have buy and hold beating active trading most of the time.