Han Dieperink: Permabulls versus permabears
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, written in a personal capacity
People who follow the stock market professionally can be broadly divided into two groups: those who view almost everything optimistically and those who mostly see the dark side, or permabulls and permabears.
Both groups suffer from cognitive dissonance, which means they do not easily deviate from previously held views and tend to seek only confirmation of their beliefs. Cognitive dissonance leads to tunnel vision and does not contribute to better analysis.
Optimists versus pessimists
Optimists are often labelled naive, while pessimists give the impression of having thought about everything thoroughly. However, the problem for pessimists is that every correction in the stock market so far has been overcome. As a result, pessimists are almost always wrong in the long run. While it sometimes seems that permabulls overlook something in their analyses - because permabears would have factored in all risks - the opposite often turns out to be true.
By focusing on negative aspects, permabears often miss the positive aspects of the situation. This phenomenon is similar to media dynamics: bad news sells, good news does not. As a result, permabears regularly have blind spots in their analyses, failing to recognise positive developments. Or they put a negative spin on things that are essentially positive. In addition, almost everyone underestimates the adaptability of humans, which often results in positive outcomes.
Bull markets versus bear markets
The advantage of a permabull is that it gets it right more often than a permabear. Yet bread-eating prophets keep appearing who hope to become immortal by proclaiming a decidedly negative view at exactly the right time. After all, such a reputation can lead to a series of lucrative books and many lectures. Their popularity tends to decline as stock markets continue to rise. Markets are now much more likely to show a positive trend than a negative one.
Over the past 50 years, there have only been six bear markets, with an average duration of just over a year. In the same period, the US stock market (S&P 500) has risen no less than sevenfold. Every permabear wishes in retrospect that he or she had been a permabull.
A falling stock market is often accompanied by a recession. Recessions do not usually last long either. According to the National Bureau of Economic Research (NBER) - the body that officially determines whether there is a recession - the average recession lasted about 17 months between 1854 and 2020. Since World War II, that average has actually fallen to 10 months. Since 1945, the United States has experienced 12 recessions, covering a total of about 13% of the time. Moreover, about 8 out of 10 recessions coincided with a bear market.
The usefulness of recessions and bear markets
Just as a recession cleans up the economy - by allowing opportunity-less companies to give way to opportunity-rich ones, thereby encouraging innovation - a bear market cleans up the stock market. The average decline during a bear market since 1928 in the S&P 500 is as much as 35.6%.
Yet the long-term chart shows mostly that the stock market is rising almost continuously. This is possible because stock markets rise much harder in positive periods than they fall in negative ones. Moreover, if the stock market halves, it can then rise by 100% to reach its original level again. A bear market leads to lower valuations and less euphoria, providing a solid basis for above-average returns in the future.
Predicting top or bottom
Unfortunately for permabears, it is easier to predict a bottom in the stock market than a top. This is because stock markets can behave euphorically for a long time. Even during the upward phase of a hype, more and more people warn about its risks. Ironically, these warnings often only encourage the hype.
Famous is Alan Greenspan's warning - for irrational exuberance in December 1997, when he was chairman of the Federal Reserve. His warning was a starting point for one of the biggest stock market rises ever.
At the height of the hype, the voices of the permabears quiet down, and when things get tough, they too become optimistic. Only when almost everyone is positive does it become time to become cautious.
In contrast to prolonged euphoria, a decline is usually much more concentrated. The stock market falls faster than it rises because anxiety and fear are more contagious than optimism. Because of this contagiousness, at some point almost everyone becomes negative. This creates the ideal recipe for blindly entering just then.