HOW SKEPTICISM GIVES RISE TO BOOMING BULL MARKETS
This article also featured on Forbes
The past 11 years in the financial markets have taught investors that a) analysts, brokers and traders are all out to take advantage of them b) financial managers are liable to steal your money to finance yachts, expensive homes and odd pieces of artwork c) the financial system can collapse at a moments notice d) all bullish moves in the stock market are temporary in nature.
During this time period investors have experienced not one. Not two. Not three. But rather a multitude of catastrophic economic events that have eroded the trust of the general investment public to a point where the boogie man is standing around every corner awaiting his opportunity to eat them.
It is only natural that a great bull market would spring from such a devastating potpourri of psychological trauma. Disallowing all but a few investors the opportunity to get into the financial markets at a point where the potential to create wealth is at its greatest, while the threat of catastrophic losses has been greatly diminished.
The psychological underpinnings that create support for the general markets here are based on the conditioning that the financial markets have done their utmost to impress upon investors over the past decade. It is similar to the effects of a haunted house during Halloween.
You are trained to believe, and rightfully so, that there are scary things hiding behind paintings, corners and walls. You go into the haunted house with your guard up. Walking slowly to make sure that you don't run into anything that will cause you to lose your dinner. As you walk through the haunted house a ghost will frighten you at some point. A vampire will jump out at another. You can't help but sense that around the next corner will the most frightening ghoul of all.
Bear markets brought on by financial catastrophe in the form of fraud, leverage and greed are the financial markets version of a haunted house. This haunted house, however, can last for years on end. The ghouls, goblins and vampires in the form of unregulated CDS contracts, overleveraging, Bernie Madoff, internet stocks and sub-prime mortgages are sure to rear their ghoulish heads again. It's right around the next corner. The popular thinking is one of safety and conservation in order to avoid the awful feeling of having your bowels displaced.
The natural question becomes why do great long-term bull markets invariably arise from a haunted house type of market environment? It has nothing to do with fundamentals. It has nothing to do with the technical picture. It has everything to do with the support dynamic that arises from the type of trauma we have experienced over the past decade.
Individual investors, hedge funds, pensions, mutual funds and every other breathing organism on Wall Street continue to have their risk antennas in a fully raised position. The memory of the onslaught that was 2008 does not go away easily. Many of the professional investors that weren't wiped away from the near collapse of the financial system suffered thirty percent plus drawdowns.
With that type of devastating flashback in the forefront of an investors mind, along with the widely held belief that another catastrophe is around the corner, professional investors become sell trigger happy. They will begin hedging and trimming exposure at the first sign of trouble. Individual investors will begin put buying, selling short and getting out of longs anytime the markets fall by more than five percent over a period of days or weeks.
When the financial markets begin stabilizing, these sellers turn back into buyers, either covering shorts or buying back into longs that were dumped out of fear. Wealthy individuals do their utmost to avoid two things in life: Losing money and looking stupid. No investor, whether retail or professional, wants to be that guy who got duped the tenth time around when the financial markets succumb to the next piece of negative news. Guards are up. Goblins are around every corner.
The very fear with which investors are operating in today's environment is the greatest safety net of all. It allows the markets the ability to experience shallow pullbacks, creating a perfect technical picture, while the fundamental scenario on both a micro and macro level continues to improve. It allows for a cycle of bids to appear in the marketplace as the tide of buying moves between the various skittish groups that have been witness to a decade of perpetual fear.
In the meantime, it will be this landscape of doubt that fuels the financial markets to levels that few are expecting during the next several years. The haunted house mentality will eventually turn to a fun house mentality where screams, gasps and fear will be replaced by smiles, giggles and boastfulness.
It's only then that the support dynamic that we are experiencing today will be turned on its head and the downside will once again be at a point all the kings horses and all the kings men can't put humpty dumpty back together again.
