This time is different.
A familiar refrain, but this time it’s true. The market crash that is sometime in our future will be different.
Familiar factors that point to problems.
- Money is cheap. The cost to carry stock with borrowed money is lower now than at any time since 1937. Cheap money promotes greed. Greed is not a productive investment characteristic,
- Fear is nearly non-existent. The VIX index purports to measure people’s concern for the future. Historically 20 is average. It was over 80 in late 2008 and early 2009. Today? Less than 10. No fear is like a teenager. No respect for possibilities. Coupled with greed there is no limit to how overextended people can be.
- The market is relying on price effects more than business effects. The change n value over the past few years is not supported by business factors like market size increases, market affluence improving, and productivity. The market is made up of businesses. It must sooner or later reflect those values.
Factors we are seeing for the first time
- Index funds are becoming a significant part of the market. Index funds are not natural, they are a huge derivative. They cannot establish a stock price, only reflect it. They are algorithmic. Maintain the weighting as established. Algorithms are handy for some things but they are unpredictable when something happens that is not part of their programming. It is difficult to create a database of things that have never happened.
- High velocity trading was possible in the past but only with great difficulty and for a tiny share of all the trades. Today volume of high velocity trades is nearly half of all trades. The average trade lasts only a few tenths of a second. The factors that make that trade work are not related to investment. Half the trades are part of a game where you do not participate. You can have no idea if the results from the conglomeration of high velocity, investment, and index trades mean anything to you.
- Information, both factual and opinion is in vast supply. People can easily and inexpensively run their own portfolio. These investors will panic if the market falls 30% or so. Just like 2009. How is an investor to decide what information to use? In older times information was hard to get and valuable. Now, too plentiful and likely meaningless. The result is conflict, and conflicted information leads to chaos.
The combination of factors is ominous
The next crash will be very quick because of greed turning to fear and the weakness of self directed portfolios.
Index funds can easily reverse if only a few big stocks get hit by panicky investors. Remember index funds rely on prices created elsewhere and their algorithms will support the trend.
High velocity trades will have little effect. They relate to neither business nor to the market pricing system. They relate to inefficiencies in posting prices.
Defense always costs
There are no greedy guys on the defense side of the game. Defense means holding assets that will be useful when trouble comes. Cash looks good and earns nothing in the interim.I know people who like precious metals. Might work. Bonds might work too, but only if interest rates remain low or fall.
Diversification is a way to help yourself, but in times of panic, all the sectors are correlated. Panic is contagious.
It is time to take defense more seriously than people have in the recent past. The problem is best articulated by basketball great Michael Jordan,
“Offense is fun. Defense is work”
Defense costs now, failure to prepare will cost later. Defense wins championships.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. email@example.com 866-285-7772