The bubble conversation.

"Investors get scared, and they decide to increase their cash allocations from (say) 5% to 20%, to 'preserve capital' in the face of the newly-uncertain environment, and 'prepare for future opportunities amidst the coming downturn'. They do this because they believe an abundance of caution to now be warranted given what has become an extremely uncertain/risky outlook, and also because they mistakenly believe that because the economic fallout is likely to last quite some time, that markets will also inevitably continue to go down/remain weak for a long time to come as well. Ego, 'future opportunities' will be significant, and cash will allow them to take advantage of them.

The problem with this perspective and behaviour is that it is classic 'first-level thinking', instead of the more desirable second-level thinking necessary in markets (hat tip Howard Marks). What investors fail to understand is that it is precisely the synchronised move to higher cash allocations and a more defensive positioning mirroring their cautious outlook - which they themselves were very much a part of - that caused the market to crash in the first place. If everyone increases cash allocations from 5% to 20% at the same time, markets will crash, regardless of the cause. And that has absolutely been the case, from retail to institutional investors, to insurance companies and other institutions alike (QBE Insurance, for instance, recently came out and said they had "materially de-risked the investment book including exiting all equities, emerging market and high yield debt"; HK Exchanges similarly exited 100% of its equity exposure in March and early April).

The thoughtful market observer would ask the question, so what happens next? Most of these investors don't plan to continue to hold 20% cash indefinitely. They are looking to re-deploy it back into equities at a time they perceive to be more opportune. What they really mean when they say that is 'when the outlook is less uncertain and they feel more comfortable', but what they overlook is that sellers will also feel more comfortable at this point; however, the important practical point is that it means they will be future net buyers of equities. Furthermore, they have already sold as much stock as they want/need to sell in order to feel comfortable with their remaining exposure in the face of what they expect will be considerable economic fallout in the medium term. Given their already very cautious outlook, it is therefore unlikely they will sell a whole lot more in the future.

What has happened at this point is that a previously unknown unknown has now become a known unknown, and consequently is now already factored into investor risk appetite and market positioning, and so it ceases to have much impact on market prices. And this is true regardless of whether the underlying economy is weak or not, because the economy does not drive stocks prices - demand and supply do. At this point, and in contrast to the intuitions most recently-scared investors harbour, a further market crash actually becomes extremely unlikely, and those sitting in cash hoping for more of the same are very likely to have their hopes dashed.

This is why markets almost always bottom well before the real economy, and recover in a manner that confounds most investors. Right when the majority of investors have just finished selling down, raising cash, and positioning themselves cautiously and in preparation for the 'coming downturn' and the 'buying opportunities' sure to emerge therefrom, markets start to rally and the opportunities they had hoped and expected to encounter swiftly disappear. The buying opportunities are not created by the economic downturn per se, but investors preparing for the economic downturn by raising cash.

They are left high and dry holding a bunch of cash. They are confused, and perhaps even angry at the market for behaving so irrationally, and ignoring how bad things are in the real economy. They claim investors are ignoring economic realities. They say the rally must be a dead cat bounce. They say bear market rallies are common and investors are being fooled by it. They say investors are too optimistic on the speed of the recovery. They say it's because investors are overly acclimated to 'buying the dip', etc. They use every excuse they can muster to avoid admitting to themselves the sad reality that they may have sold at the bottom, just like patsies do every bear market. What they are really doing is hoping markets go back down so they have a second chance to buy stocks as cheap as they were recently trading, but with so many cashed-up investors similarly hoping for a further pull back, such an outcome is inherently self-defeating. There is simply too much cash on the sidelines waiting for an opportunity to buy the second dip for markets to go down enough to retest their lows.

There never has been, and never will be, a law of the universe that dictates that stocks will go down just because the economy remains weak, and the actual truth is that markets almost never go down much - if at all - when investors are already cautiously positioned for a known unknown, and are already holding a lot of cash in preparation for a difficult and uncertain future. They go down a lot when people go from being aggressively positioned to defensively positioned en mass, because they were not previously expecting future turmoil/economic stress, and they now are. Once people are defensively positioned, markets are apt to rise because the selling pressure of people moving into a defensive position abates, and there is far more latent buying lying in wait (i.e. all the cash people raised to take advantage of buying opportunities), and too few sellers left.

Every single time there is a recovery from a major economic shock/market sell-off, the same thing happens; people react with the same credulity, and believe the market is ignoring the fundamentals. Throughout the substantial 2009 market recovery from the GFC lows, there was widespread skepticism about the durability of the rally. Didn't people know that the economy is in a mess and it is going to take years to recover from it? Yes, they did, and that was the whole problem. It was no longer an unknown unknown. The economy contracted throughout 2009 and unemployment continued to rise, and yet stocks continued to rally, not only through 2009, but for the next decade." (https://lt3000.blogspot.com/2020/05/coronavirus-update-from-unknown-unknown.html)


There will be corrections and more significant declines at times in the future. If you have a long-term view, you will view these as opportunities. If your view is basically, "WHAT IS THE MARKET GONNA DO TOMORROW?" then investing is going to quickly become stressful and frustrating. Some of this sub has spent much of the last 5 years basically on "market crash watch" and obsessing over what might cause the slightest bit of market volatility in an attempt to avoid it.

The incessant desire to be bearish and the Burry-esque obsession with finding the "NEXT BIG SHORT" has been wrong on here for years but then when markets actually did decline significantly (see December 2018, March of this year), much of this sub was spectacularly bearish at the wrong time and certain that the market would go lower. Throughout the rise, off the low it's "the market isn't doing what I* think it should be doing." (the market doesn't care what you think it should be doing - invest in the market in front of you, not the one you think it should be.)

"Bubble" has been over-used on this sub to the point of absurdity over the last half decade (I feel like I've read "the bubble conversation" on this sub a thousand and one times over the last 5 years) and the pessimism/desire to embrace being bearish on here has resulted in years of dislike of the market and when that bearishness is proven to be mistaken, rather than re-assess, people instead strain to find some new reason to be bearish. Or its the "not wrong just early" nonsense (can never be wrong because you can keep saying "just early" and moving the goalposts.)

I agree with what u/AccomplishedClub6 said, too.

/r/investing Thread