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Everyone loves a rising market. The longer, the better—what everyone wishes for. This creates the wealth effect, which leads to higher consumption and spending and thus contributes to GDP growth, which feeds into higher stock prices. Under all the glitz and glory, something is becoming unfavorable.
There is a bad in every good thing and a good in every bad thing. Like the circle of life, good times are followed by bad times, and bad times are followed by good times, stock markets also go through cycles of excessive greed/optimism to excessive fear/pessimism.
For the sustainable long-term progress of financial markets, corrections are healthy and useful. Equity markets corrected by more than 50% in 2000-01 and more than 60% in 2007-08 which lasted for 1.5-3 years. Since then, there has not been a significant decline that lasted for even a year. Making this bull market probably the longest in many decades.
The negative aspects of prolonged bull markets without much volatility are:
– Breeds complacency due to recency bias that nothing can go wrong. This results in people taking excessive risks than what they are capable of.
– Shady operators have a field day by usually scamming people by pumping & dumping bad stocks.
– Luck due to rising tide is confused with brains leading to overconfidence & misallocation of capital
– More and more savings go to equity markets at higher valuations leading to disappointments and agony when the tide turns
A thoughtful investor shouldn’t get swayed by bull markets or bear markets but should logically follow an asset allocation strategy suitable to his/her risk profile. The one who is undeterred by greed (due to FOMO) or fear (due to loss aversion) gets the staying power and enjoys the fruits of investments in the long term. Sticking to a long-term sustainable strategy helps bring discipline.
Looking closely at your portfolio allocation should be done at all times and not just when the market corrects.
Morgan Housel rightly said “Calm Plants the Seeds of Crazy”. Be prepared for crazy when the markets are calm.
Originally posted on LinkedIn: www.linkedin.com/sumitduseja
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