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Ostrich Investors Are Driving Today's Financial Markets

Ostrich Investors Are Driving Today's Financial Markets

US stocks are in a great place in their bull-bear cycles to rally strongly in the coming months.

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By Adam Hamilton & Scott Wright 30.08.2010

Ostrich investors are a major driving force in today’s financial markets.  As the name implies, they are hiding their heads in the sand like the popular literary perception of the king of birds.  Burned in 2008’s epic stock-market panic, they have shunned active investing ever since.  Trillions of dollars of their capital languishes idle on the sidelines, earning zero in money markets or near-record-low yields in Treasuries.

I can certainly sympathize with them.  In the heart of that brutal once-in-a-century stock panic in October 2008, the flagship S&P 500 stock index plummeted 30% in a single month!  Elite blue-chip stocks long considered safe failed to weather that fear storm well.  Because the economy has been slow ever since the panic, countless investors fear another extreme selling event.  They still want nothing to do with stocks.

The reasons for investor anxiety today are legion.  Investors fear a new recession, the ever-popular double-dip scenario of heading back into economic contraction.  They worry about the sorry state of the jobs market, consumers’ ability to spend, and the shaky housing market.  They fret about the incessant and stifling growth of big government in Washington, and the Democrats’ threats of record tax hikes.

It’s not a pretty environment out there, so it isn’t illogical to hide heads in the low-yielding sands of cash and bonds.  Unfortunately for ostrich investors though, this strategy is doomed to failure.  While it is challenging psychologically, the active investors braving these stock markets are thriving.  Our wealth is multiplying while ostrich investors’ is stagnating.  Those hiding out too long will never catch up.

I wrote my original ostrich-investors essay 16 months ago, fresh out of the despair lows in early 2009.  At the time countless worries plagued the markets.  Economists were convinced we were heading not into a recession, but a depression. 

If there was ever an environment that encouraged ostriching, early 2009 was it.  If you had moved your capital to cash then, you’d essentially have the same amount today.  But boy the opportunity cost of hiding on the sidelines has been staggering.  Between March 2009 and April 2010, the SPX blasted 80% higher in a massive post-panic recovery.  Believing the pervasive gloom and doom back then nearly cost you a doubling of your capital!

You have to consider cycles and sentiment.  Stock markets move in great 34-year cycles I call Long Valuation Waves.  The first half is a 17-year secular bull, like we saw from 1982 to 2000.  The second half is a 17-year secular bear, like we’ve been experiencing since 2000.  Within these sideways-grinding secular bears, smaller multi-year cyclical bulls and bears oscillate. We are in one such mid-secular-bear cyclical bull today.

Cyclical bulls within secular bears average 3 years in duration, but can be as short as 2 or as long as 5.  Yet our current one was only 13 months old in late April when the stock markets peaked before their recent correction.  This bull was far too young to give up its ghost then, which strongly suggests it is very much alive and well today. 

In addition, secular bears have giant horizontal trading ranges.  In SPX terms our current one runs from roughly 750 on the low side to 1500 on the high side.  We hit this upper resistance in late 2007 at the top of the last cyclical bull, and lower support in late 2008 at the height of the panic.  Today the stock markets remain low within this secular-bear trading range.

The upshot of our position today in these critical cycles that all investors should study is that probabilities strongly favor the stock markets rallying from here.  These bull-bear cycles are strong and nearly ironclad, nothing stops their ultimate progression.  All the news you hear every day, all the anxiety and worry, is nothing but ephemeral noise.  The markets are always fretting about something, but it is soon forgotten (remember European sovereign debt, the oil spill?).

With our position in the bull-bear cycles firmly on investors’ side today, ostriching now is as irrational as it was in early 2009.  Sure, you can bury your talents in cash over the next year and dig them up with just minor real losses after inflation.  But that is not investing, it is just poor stewardship.  If you take a little time to learn about the markets and seize the opportunities, you could really grow your capital in the coming year.

In addition to the cycles, all this rampant fear and anxiety itself is extremely bullish.  Sentiment is all-important in the financial markets, driving most short-term price action.  Sentiment is like a giant pendulum, perpetually swinging back and forth between greed and fear.  When stock prices have long been rallying to highs, greed reigns supreme.  When they have been falling to lows, fear dominates.  But like a pendulum, once either extreme is reached you can be sure the next extreme will be the opposite one.

There is no doubt that this US summer has been dominated by the fear side of the sentiment continuum.  The stock markets have been weak thanks to the major SPX correction in May and June.  Investors are scared of countless threats, worried that something even worse is coming.  As is always the case when stock markets are weak, bearish and pessimistic theories dominate newsflow and consciousness.  When prices are down, investors want to be scared and look for reasons to rationalize their emotions.

Yet it is fear episodes that birth all great rallies.  Eventually fear and anxiety drive everyone interested in selling anytime soon into pulling the ripcord and bailing out.  And once this selling-exhaustion threshold is hit, there are no more sellers left.  Then no matter how bad the news is, the markets start rallying anyway because only buyers remain.  And after this new rallying is established for a few weeks, newsflow turns positive as investors start feeling greedy and look for justifications to buy.

The great sentiment pendulum endlessly swings from greed to fear and back again.  And since it spent most of the past few months deep into fear territory, the only place it can go from here is back towards greed.  The only thing that can drive widespread greed is a big rally.  Thus in pure sentiment terms, the stock markets are perfectly set up to enjoy a major rally in the coming months.  The markets abhor extremes, and fear has ruled for too long.  Greed is overdue to make an appearance.

If you study the markets, you have no choice but to acknowledge the bull-bear cycles and the greed-fear swings in sentiment.  Many ostrich investors I’ve talked with over the past year have some level of awareness of cycles and sentiment.  But they still argue that hiding in the sand is rational, because they fear another stock-market panic or crash.  Together crashes and panics are extreme selling events.

From the widely-hailed Hindenburg Omen in the news lately, to all kinds of more obscure theories, perma-bears offer dozens of reasons why we face a crash or panic this autumn.  Never mind that these perma-bears always think a new crash or panic is imminent!  If you follow one of these guys, read what he was predicting back in early 2009.  It will be a crash or panic, not the massive rally I predicted then.  Gloom and doomers are broken records, they perpetually forecast calamity and lead investors astray.

An extreme selling event in the coming months is terribly unlikely, its probability approaching zero.  Ostrich investors need to understand this, as constantly expecting an event with exceedingly-low odds of occurring is no excuse for burying their capital in the sand.  There are a couple key reasons why we won’t see a crash or panic this autumn.  Today’s bull-bear cycles are in the wrong place to spawn them and the last extreme selling event happened too recently.

Crashes, a 20%+ plunge in the stock markets in a matter of days, only occur at one very specific time in cycles.  Crashes always erupt near multi-year highs deep in secular bulls, like in 1929 and 1987.  Crashes are born in extreme greed when retail investors are fully deployed and almost no one is hiding in cash on the sidelines.  Obviously today with widespread fear and ostrich investors hiding trillions in cash, this environment is all wrong for a crash.  And the April SPX high of 1217 was far below the October 2007 high of 1565 at the end of the last cyclical bull.  A crash ain’t gonna happen folks.

Panics, a 20%+ plunge in the stock markets in a matter of weeks, also only occur at one very specific time in cycles.  Unlike crashes starting from multi-year highs, panics cascade out of lows in cyclical bear markets.  A bear persists for a year or so, mauling about 25% out of the stock markets.  Then some high-profile catalyst ignites a frantic rush for the exits, and the resulting intense selling drives another 20%+ loss in a matter of weeks.  Like crashes, panics require heavily-deployed retail investors.  People have to be in before they can panic!

We aren’t at the end of a multi-year bull near multi-year highs, so no crash is coming.  We aren’t a year into a cyclical bear near lows, so no panic is coming.  And extreme selling events can’t happen in an environment like today’s plagued by ostrich investors, when trillions of dollars are already hiding outside of the stock markets.  Extreme-selling-event-magnitude declines require fully-deployed investors.  Even Wall Street often acknowledges how chronically underinvested people are today.

Proximity to the 2008 panic is another strong argument against another extreme selling event anytime soon.  Extreme selling events are so scary that everyone without nerves of steel is driven to sell.  Some of these investors are so discouraged they never come back, and others gradually tiptoe back in over years.  So throughout market history, you always see at least a decade between extreme selling events.  It takes that long after one for enough investors to quit worrying and get fully deployed again.

So ostrich investors can’t latch on to some perma-bear’s flawed extreme-selling-event thesis and use that as an excuse for abdicating their family’s financial stewardship.  Probabilities are virtually zero of seeing another panic or a crash anytime in the coming years.  And without extreme-selling-event worries, the bull-bear cycles and sentiment pendulum become even more compelling.  They are very bullish today.

Ostrich investors have really lost out since the panic, giving up nearly a doubling in their wealth.  But they don’t need to bear such crushing opportunity costs forever.  If you have been hiding out in zero-yielding cash or low-yielding bonds, get back in the game!  Start redeploying a small fraction of your capital in stocks.  As you get more comfortable and enjoy gains, gradually move more of your capital back into stocks.  Eventually you’ll be out of ostrichdom and back into wise financial stewardship of your family’s future.

The bottom line is there is no excuse to be an ostrich investor.  Hiding your capital in the zero-yielding cash sands is a failure, a millennia-old abdication of stewardship responsibility.  Tough markets are not as easy to grow your wealth in as normal markets, but with a little time and effort you can still thrive as an investor.  Get your anxiety and fear in check, buckle down, and start investing to win again.

The markets are actually very bullish right now, with almost no chance of an extreme selling event like the perma-bears perpetually prophesy.  Stocks are in a great place in their bull-bear cycles to rally strongly in the coming months.  And the very poor sentiment we’ve weathered this summer ensures the next sentiment swing will be towards greed.  The only thing that can generate it is a major stock-market rally.

© Copyright 2000-2009, Zeal Research (www.zealllc.com). Zeal Research is a US-based investment research company - you can visit their website at http://www.zealllc.com/. Zeal's principals are lifelong contrarian students of the markets who live for studying and trading them. They employ innovative cutting-edge technical analysis as well as deep fundamental analysis to inform and educate people on how to grow and protect their capital through all market conditions. All views expressed in this article are those of the author, not those of TheBull.com.au. Please seek advice relating to your personal circumstances before making any investment decisions.  

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