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Big Idea | If It Pays to Be a Bull, Why Does Bearishness Persist?

Bear investors sound smart. They make us doubt bullish arguments. They prey on our natural risk-aversion.
Top bear strategies last week

Pity the poor bear.

He roams the forest with his head slung low, avoiding contact with anything that might cause even a scratch for fear of infection. His diet consists of blueberries and fish – they don’t put up much of a fight. Unlike other apex predators, he enjoys a long life. But, let’s face it, it’s not a glorious one.

The bear investor is not much different. He sounds warnings in both up and down markets, proclaiming the end is nigh (again). If you listen to him, you risk missing out on returns that can make you wealthy.

The stock market bear is often held in higher regard than his opposite, the bull. He gets all the headlines, warning of doom and gloom, erroneously connecting the dots between economic reports and a collapse in equity prices that never arrives. Jeremy Grantham of GMO in Boston is considered the embodiment of the bear – he’s even called a “permabear” — having predicted 19 of the past two stock market corrections, the joke goes.

So why is the stock market bear, er, lionized, while the bull – that hard-charging symbol of positive momentum – relegated to an inferior class?

It’s because bears sound smart. They make us doubt bullish arguments. They prey on our natural risk-aversion. And when it comes to money, we want to be smart. But research shows that investors ought to favor bullishness in the stock market.

How did this inversion come to pass?

The question isn’t academic. The U.S. benchmark for stocks, the S&P 500 Index, leaped 15.9% in the first half of the year. The Nasdaq Composite Index, which contains a higher proportion of riskier stocks, did twice as well, marking the best start to a year in four decades.

Bears — among them professional strategists including Mike Wilson of Morgan Stanley — largely sat out the fireworks. Wilson said during the year’s first full week of trading that investors are dangerously unprepared for a weak earnings season. He predicted a drop of as much as 23% in the S&P 500. After his outlook didn’t come to pass, he sent out a warning signal in June, saying the chances of a major market correction have rarely been higher.

There are three main ways stock market bears confound themselves – and, often, others. And they have to do with humans’ hardwiring for risk avoidance:

1. Bears are, by nature, conservative. 

To them, the world is replete with risks. But while protecting the downside is always prudent, America’s economy runs on innovation. And that leads to dynamic companies that are often overvalued, which is kryptonite to bears. Still, some richly priced newcomers become stalwarts – think of Alphabet, Amazon, Netflix, Tesla, among others – that propel the market and often end up as members of the selective S&P 500.

Bears suffer from negative confirmation bias; they remember negative events more than positive ones. (While all people fall prey to it, we can overcome this destructive way of thinking.)

Bulls, on the other hand, are open-minded. They tend to be growth-style investors who believe in progress and bet that the future will be different than the past.   

2. Bears are fond of “macro” analysis. 

They tend to connect  global economic events to the stock market. Logicians would point out that this view incurs a number of infractions — the fallacies of accident (the assumption of a general rule that applies to a particular situation), false cause (a nonexistent cause-and-effect relationship) and hasty generalization (making a claim about something without sufficient evidence).

Cause-and-effect plays to humans’ propensity for pattern matching. But it’s one of the most unreliable traits, as we often make connections that don’t exist. This turns out to be an expensive mistake.

As for macro analysis, the economy is not the stock market, and vice versa. Investing is sometimes counterintuitive: A bad economic report might prompt a central bank to relax monetary policy, thereby lowering borrowing costs and potentially boosting profits.

The stock market is multilayered and complex, not linear. Investors must take into account a range of inputs in stock prices — including valuations (price-to-earnings ratios, for example); Federal Reserve policy and the direction of interest rates; professional investors’ positioning and hedging; fund flows; the options market’s influence on demand for underlying securities (stocks, in this case); relative values among asset classes (stocks versus bonds versus commodities, among others).  

3. Bears ignore math.  

This includes the laws of probability and compounding. The stock market tends to rise over time, and is up two of every three years, on average. It returned an average of 12.3% from 1926 through 2021, almost twice that of a bond portfolio.

Compounding does the heavy lifting for you. An initial investment of $100,000 that returns an average of 12.3% a year for 40 years nets $9,763,957.  

As Warren Buffett’s investing partner Charlie Munger said: “The first rule of compounding: Never interrupt it unnecessarily.”

And as Albert Einstein explained: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”

All this is to say that bears sound smart, but bulls make money. Be a bull.

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