“Bull markets are born in despair, grow amid skepticism, mature in optimism, and die amid euphoria.”
Sir John Templeton
My son Jack likes to ask people about Theseus’ boat. It is a classic intellectual puzzle, which explores the nature of being. If an object has continuous presence in the world, but every element of it has been replaced, does it remain the same thing? The question might be phrased as, “Does Theseus’ boat still exist?”
Theseus’ boat was in ancient Athens. I’d like to explore the nature, age, and prospects of a very different thing, namely the bull market.
Sir John Templeton was one of the last century’s greatest investors, often considered the father of international value investing. Way back in 1981, when I was a young stockbroker, an article by Templeton convinced me to buy stocks, at a time when Business Week‘s cover had just announced “The Death of Equities.” I found Templeton to be one of the clearest thinkers and writers about investments, in the same must-read category as are Warren Buffett and Jeremy Grantham today. One of John Templeton’s most famous quotes links investor sentiment with the market cycle: “Bull markets are born in despair, grow amid skepticism, mature in optimism, and die amid euphoria.”
I find this specific Templeton quote of greater value than any other single insight about investing I’ve encountered in my thirty-five years of running other people’s money. His words provide me with the confidence to buy during market panics, at the same time that many of our peers, and even more individual investors, often lose their nerve and sell.
Understand that TGS Financial Advisors does not make discrete buy and sell decisions based on our assessment of market psychology. All of our portfolio allocations are data-driven, and are based on absolute prices, relative prices, or relative yields. Yet at market inflection points, we have consistently found that the fund flows trigged by our portfolio algorithms are confirmed by our seat-of-the-pants observations of investor sentiment. (Understand that this is a negative confirmation, not a positive one. Panicky investors equals buying opportunity, just as greedy investors is grounds for caution.)
Implicit in Templeton’s wisdom is the eternal disconnect between market psychology and market value; sentiment drives price near-term, but value always trumps long-term. Bull markets proceed from a condition of under-valuation (during the despair phase), through fair valuation (at the transition from skepticism to optimism), and eventually all the way to over-valuation (once sentiment reaches euphoria). As Jeremy Grantham notes, most of the time the market deviates from fair value, though the gap is not always large enough to create profitable investment opportunities.
So what about Templeton’s Bull? Does he still have room to run? This is a variant of the classic road trip question, “Are we there yet?” Or have we already reached the condition of euphoria that marks the end of the bull market?
My gut reaction is, this bull-market cycle is probably not yet over. Since March 9 of 2009, we have had a 175% bull market run against a backdrop of pretty consistent skepticism. As many observers have commented, this might be the most unloved bull market of all time. Recent investor sentiment qualifies as optimism, though not yet as euphoria. (I’m discounting Jim Cramer, who oscillates between euphoria and despair on a short-term cycle, and is useful only as a reverse barometer, if at all.)
If we haven’t yet reached a state of euphoria, doesn’t this prove the bull market isn’t over yet?
I’m not fully convinced. The emotional landscape of the future must always remain an undiscovered country. Anyone who is married knows the entire impossibility of predicting the future emotional state of a single human being, even that human being we know best in all the world. Predicting the future sentiments of millions of investors is impossible.
One of our best measures of market psychology is our communications with our own clients. At market bottoms, a decent number of clients want to sell out. At market tops, quite a few clients want to chase performance. Not every client, surely, but enough at market extremes to provide a robust contrary indicator.
Recently, we have been raising cash in our portfolios. So far, only one client has called to complain that we aren’t fully invested. We haven’t lost a single client who is seeking greener pastures in more-speculative stocks. This does not seem to me enough push-back for this to be a final bull market top.
Every bull market is different. Sometimes bull markets end, not with a bang, but with a whimper. For example, the 2007 market high was less than euphoric. Will the bull market that began in 2009 end like the 2003-2007 recovery, with risk spreads narrow and stock prices high, or like the great bull market of 1982-2000, with spreads narrow and stock prices utterly insane?
We don’t know, and can’t. So we rely on hard numbers on valuation.
Those hard numbers caused us to be overweight stocks months before the market bottom in March of 2009, a posture that was very profitable for our clients as the market recovered. Today, it is just the opposite. T he numbers cause us to be underweight stocks, and overweight cash. Now as then, we are confident our posture is rational, and guardedly optimistic that markets will prove us right—eventually.