Edge: Michael Kitces

At a high level, I actually think the thing that’s getting the least attention that we SHOULD be worrying about is a good old-fashioned bear market in stocks. Everyone is SO fixated on the bear market in bonds, and either suggesting that stocks are a place to run (which I’ve expressed concern about here) or at the least ignoring that stocks aren’t exactly in a great position either (overbullish, overbought, slowing economy, yadda yadda).

No, that doesn’t necessarily mean I’m a fan of trying some short-term timing here, but I think the whole finance/investing world grossly underestimates how much a third bear market in 13 years is going to damage investor psyche… as markets fall AGAIN to the price levels they were ~15 years ago in the mid-to-late 1990s.

When you look at the long-term trends, valuation tends to regress not to the mean, but to the lows (per Shiller P/E10 charts and a lot of Ed Easterling’s research). There’s only one way you regress to the lows – you need investors in the aggregate to REALLY capitulate and forsake stocks for a while. We have not had that kind of washout yet. When it shows up, it will be absolutely brutal to the industry. Finance and investing will survive (just as it has through all the other cycles of history), but it will be a purging unlike anything we’ve seen even through the financial crisis. I separately worry what it will do to the financial planner community in particular (see here, for example) as the whole personal finance world has basically hitched its wagon to “stocks for the long run.”

So simply put – will the next STOCK bear market generate a “3 strikes and you’re out” response from the retail investor? And will it be even worse if/when it COINCIDES with a  bond bear market as well?

The Edge Question series:

• Edge: What Should We Be Worried About?
• Edge: Tadas Viskanta
• Edge: Kent Engelke
• Edge: Tom Brakke
• Edge: Doug Short
• Edge: Michael Kitces
• Edge: Milevsky, Ritholtz, Zweig, Ferri and More

Michael Kitces is Director of Research for Pinnacle Advisory Group.

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