Fear Not

When I was a ninth-grader, my high school showed Alfred Hitchcock’s classic horror film, Psycho, in the school auditorium on a snowy Friday night. I desperately wanted to be and look cool, but when Martin Balsam’s Detective Arbogast climbed the stairs in the old house behind Bates Motel to meet Mother, I dove under my seat in terror. Warning: The clip below is still scary.

We all face fear. We. All. Face. Fear. “Forty-five on the back of the jersey upon your soul.”

Investors have to face fear every day, although more so on some days than others (nobody complains about volatility to the upside), and don’t often face it very effectively. To quote Jason Zweig paraphrasing Mike Tyson, “investors always have a plan until the market punches them in the face.”

Real fear comes with names, faces, and a story. And oh how we want deliverance from our fears. Now that downside volatility is back with a vengeance, market commentaries are full of fear stories, since markets are driven by narratives much more than they are driven by data. As Morgan Housel has cautioned: “The business model of the majority of financial services companies relies on exploiting the fears, emotions, and lack of intelligence of customers. The worst part is that the majority of customers will never realize this.”

Outspoken money manager and economist John Hussman is once again calling for a severe market crash that would send major U.S. stock market indices plummeting by 60 percent or more (more or less), resulting in losses of roughly $20 trillion, and he has positioned his firm accordingly. The details may have changed, but this is a tired and familiar story. He has been warning that stock valuations have been extreme for more than a decade (“overvalued, overbought, overbullish”), and long overdue for a return to historical norms (as documented by his regular market commentaries).

Hussman’s flagship Strategic Growth Fund, after excellent returns during the Great Financial Crisis, has suffered dreadful performance since, with three, five and ten-year annualized return numbers all well under water (as of December 10, 2018: -6.70 percent; -7.43 percent; and -5.56 percent) during a period when the S&P 500 (for example) has gone gangbusters (10-year returns of roughly 14 percent per year). After some surprising clawbacks in Bankruptcy Court, if now appears that those who “invested” in Bernie Madoff’s multi-billion dollar Ponzi scheme (Madoff was arrested almost exactly ten years ago), despite major losses due to Madoff’s perfidy, still outperformed those who invested in Hussman’s fund at the same time by about 10-15 percent. Once the ten-year numbers are fully removed from his GFC success, Hussman’s returns will look even worse. He has lost assets accordingly, from a 2010 high of $6.7 billion to barely $300 million today.

Still, tomorrow is another day.

“There’s always the hope that this time it’s different,” Hussman says. Hope always seems to spring eternal for underperforming money managers, so long as they are still collecting management fees (a few notable exceptions notwithstanding). Hussman insists he has learned from his mistakes, that he now recognizes that there is no “limit to the recklessness of Wall Street.” But he keeps losing money, longing for the day when he will – finally – be right again.

Hussman is far from the only permabearof course. As Barry Ritholtz has entertainingly outlined, former Reagan White House Budget Director David Stockman has predicted market crashes in 2012, 2013, 2014, 2015, 2016, 2017, 2018, and 2019. And “Dr. Doom,” Marc Faber, he of The Gloom, Boom & Doom Report, regularly and routinely called for corrections and crashes (“bubbles everywhere”) on various media before being exposed as a racist and largely disappearing from view. Others include Nouriel RoubiniPeter Schiff, Stephen Roach, and David Tice. Permabears exist despite the upward trend of the markets because these alleged oracles garner clicks, eyeballs, attention, television appearances, and assets. It pays.

“Fear sells. Fear makes money. The countless companies and consultants in the business of protecting the fearful from whatever they may fear know it only too well. The more fear, the better the sales.” That short summary from The Science of Fear, by Dan Gardner, is perfect. Gardner goes on to recount how post-9.11 fear dramatically reduced air travel and led to many, many more driving trips. However, if a 9.11 impact attack had happened every single day for a year, the odds that you’d be killed by such an attack would be one in 7,750, still greater that the actual odds of dying in a traffic accident, which are one in 6,498. Gerd Gigerenzer estimates that the increase in automobile travel in the year after 9.11 resulted in 1,595 more traffic fatalities than would have otherwise occurred. If you want to make a sale, find a bogey-man, explain why your marks should be terrified of him, tell them who is to blame for the bogy-man’s offenses, and offer a purported remedy.

I shouldn’t have to add that the alleged remedy usually costs. A lot.

We respond emotionally to stories. Moreover, fear is the most motivating of emotions, at least in the short-term. As Jeremy Siegel has explained, “Fear has a greater grasp on human action than does the impressive weight of historical evidence.” Think about it. Warren Buffett has made enormous amounts of money by following the evidence and buying stocks, which have provided consistently high returns on an unfortunately inconsistent basis for decades: “In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.” Buffett buys stocks and holds them. His “favorite holding period is forever.” The typical investor…not so much.

Even the atypical investor struggles in this regard. As Morgan Housel says, “Every past decline looks like an opportunity, every future decline looks like a risk.” Harry Markowitz won the Nobel Prize for exploring the mathematical tradeoff between risk and return. Some years ago, The Wall Street Journal asked him how, given his work, he structured his own portfolio. He replied: “I visualized my grief if the stock market went way up and I wasn’t in it – or if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions 50/50 between bonds and equities.” That may have been a perfectly appropriate asset allocation for Professor Markowitz, of course, but his thinking was far more fear-based than analytically driven.

As Duke Hall of Fame basketball coach Mike Krzyzewski adds, “Winners hate losing more than [they love] winning.” Or, as Texas Tech linebacker Dakota Allen says, “I’m just here to not let you guys down.” Per Kahneman, “the main contribution that Amos Tversky and I made during the study of decision making is a sort of trivial concept, which is that losses loom larger than gains. …As a very rough guideline, if you think two to one, you will be fairly close to the mark in many contexts.” Some have questioned this finding, especially recently, but there are good reasons for thinking that questioning is in error, reasons that every experienced financial advisor has seen among his or her clients.

We are slaves to our past experiences: “Current beliefs depend on the realizations experienced in the past” such that we fear what hurt us before and thus fight the last war (so to speak). Per Kahneman again, “Loss aversion is emotional, the reluctance is emotional, and if I’m making a decision on behalf of somebody else, I don’t feel that emotion, which means, by the way, that advisors are likely to be more rational in the long run because loss aversion is costly.”

FOMO is real too. Accordingly, performance-chasing is widespread, among both retail and institutional investors. Therefore, investor returns significantly trail investment returns.

As Andre Agassi explained, “A win doesn’t feel as good as a loss feels bad, and the good feeling doesn’t last as long as the bad. Not even close.” Or David Letterman: “Maybe life is the hard way, I don’t know. When the show was great, it was never as enjoyable as the misery of the show being bad. Is that human nature?”

Yes, it is.

When the markets are roiling, as they are now, fear is pitched all day, every day, and human nature buys it. And pays a premium. A very big premium. None of us can be entirely like Morales in A Chorus Line when it comes to our money.

“I feel nothing.”

Giving in to the fear we feel is dangerous business, of course, because the market trends solidly upward.


Betting against the market is dangerous business. Jim Chanos is probably the best short-seller in the world, which means he profits when stocks he is short go down in value. He sells stocks he doesn’t like, borrows shares to settle, pays interest on his borrowings, and hopes to make money by later buying back at a lower price. But it’s really, really hard to make money selling short. You make money in bad times (Chanos’s short fund, Ursus, made 44 percent in 2008), but mostly stocks go up and shorts lose money. Even for Chanos, “the short book — as represented by Ursus — has lost 0.7 percent annually” from founding through the end of 2017.

Think about that for a moment. The best short-seller in the world can’t consistently pick money-losing stocks.

The secret to Chanos’s success is his flagship fund. That fund (Kynikos Capital Partners, minimum investment $1,000,000), via leverage, is 190 percent long and 90 percent short, making it net long. The upward trend is his friend. Unlike most long/short hedge funds, however, the longs are primarily passive, with the intellectual effort going into the shorts. Through the end of 2017, Kynikos has a net annualized gain of 28.6 percent since launch in October 1985, more than double the S&P 500.

If you were simply to borrow money to buy stocks with 190 percent of your money, and you chose stocks randomly, you should get about 190 percent of the performance of the market, less your financing costs, which means that you will get nearly double the performance of the S&P, but also nearly double the volatility. And when markets crash, you will lose a lot of money. If you were long 190 percent and short 90 percent, and you chose stocks randomly, the holdings would largely cancel out each other, and you would earn roughly the performance of the S&P, less financing costs. But if you get long 190 percent chosen randomly, and short 90 percent very intelligently (you “only” lose 0.7 percent per year at it), you can earn roughly double the performance of the S&P without extra volatility, and when markets crash you can actually make money.

This is a textbook lesson in the benefits of diversification, of course, and of uncorrelated returns. But it also illustrates how hard it is to bet against stocks – either by shorting or by staying out the market.

On the other hand, you can always find reasons to be terrified and cash out of the market if you choose to look.


A well-crafted narrative employs Chekhov’s gun, a dramatic principle whereby every element in a story must be necessary and irrelevant elements should be removed. Accordingly, if a gun is introduced in the first act, it had better go off in the second. Unfortunately, real life isn’t necessarily well-crafted. Many a gun lies around unused in perpetuity.

Accordingly, staying in the market has huge advantages. University of Michigan Professor H. Nejat Seyhun analyzed 7,802 trading days for the 31 years from 1963 to 1993 and concluded that just 90 days generated 95 percent of all the years’ market gains — an average of just three days per year. J.P. Morgan Asset Management looked at the distribution of returns for the Russell 3000 from 1980 to 2014. Forty percent of all Russell 3000 stock components lost at least 70 percent of their value and never recovered. Effectively all of the index’s overall returns came from just seven percent of components. In other words, long-term returns accrue in bunches and, in the markets as in the lottery, you’ve got to be in it to win it (although the market offers an exponentially greater chance of success than does the lottery).


Our quite natural reaction to market volatility, to fear, is to “Bolt Everything Down,” and bail.

Doing so comes with a crazy-high degree of difficulty. Obviously, market-timing successfully means making multiple immensely difficult and complex decisions and being consistently right. Does that seem like a reasonable expectation to you?

Doing so also comes at a major cost. Were you able to avoid “just” the ten days with the biggest market (S&P 500) losses, your returns over twenty years, 1998-2017, would have increased from 7.20 percent to 11.31 percent annualized. However, were you to miss the ten best days over that same period, your returns would have dropped to 3.53 percent. Moreover, the majority of the best days occur within two weeks of the worst days, meaning that missing the worst days almost surely means missing the best days. Indeed, every S&P 500 decline of 15 percent or more, from 1928 through 2017, has been followed by a recovery such that the average return in the first year after each of these market declines was nearly 55 percent. Therefore, it generally pays to stay invested. Trying to “go to cash” at opportune times and, equally importantly, getting back in at the right time, is usually doomed to failure.

Snip20181215_3Some (very inexperienced or hard-headed) people think that one should be able to time the market so as to avoid major declines. The problem is that we think (feel!) that market timing should be possible and our hindsight bias (“I knew it all along”) coupled with our inherent overconfidence (“often wrong, never in doubt”) seem to confirm the feeling after the fact. Warren Buffett is more level-headed: “We do not have, never have had, and never will have an opinion about where the stock market, interest rates, or business activity will be a year from now.” Market timing strategies are frequently triedrarely, if ever, successfully. Academics find them sorely lacking. Market returns trail investor returns, whether the measurement is performed by Morningstar or Dalbar. Active management trails the market too.

When it comes to market-timing, the smart money sees red flags waving. Many still insist that what they’re seeing is a parade.

There are at least three reasons why it’s crazy to think that we can forecast where the market is headed, well and further supported by our consistent failures to do so. Chaos theory teaches that for complex adaptive systems, like stock markets, even a minuscule deviation in original conditions can lead to wildly different outcomes. Secondly, while classical physics assumes that if we know everything about current conditions, we should be able to ascertain absolutely what will happen next, if we look at merely three specific and interactive entities, we can’t do it. This is the classic three-body problem. The markets, with infinite numbers of potential inputs and outputs, are far too complex and random to predict.

Finally, and most fundamentally, markets are made up of the actions of people, and as Josh Brown regularly explains: “People can’t be accurately modeled. And it’s people who work and vote and invest and trade and make deals and stick things into themselves that require a trip to the emergency room.” The great economist Joseph Schumpeter, in the words of his biographer, appropriately concluded “that exact economics can no more be achieved than exact history, because no human story with the foreordained plot can be anything but fiction…. The best mathematics in the world cannot produce a satisfactory economic proof wholly comparable to those in physics or pure mathematics. There are too many variables, because indeterminate human behavior is always involved.”

Moreover, the longer the time frame we use for reference, the more powerful stocks become. Annualized returns (1928-2017) of cash (three-month U.S. Treasury bills) are 3.39 percent, of bonds (ten-year U.S. Treasury notes) are 4.88 percent, and of stocks (the S&P 500) are 9.65 percent. A $100 investment in each asset class on January 1, 1928 would have returned $2,015.63, $7,309.87, and a whopping $399,885.98, respectively, through December 31, 2017. Stock market volatility is the necessary price you pay for the much higher expected returns of stocks as compared with other investment choices. If you want to meet your long-term financial goals, stocks are by far your best opportunity for getting there.

In other words, if you don’t want to invest in equities because you fear a market crash, then you shouldn’t be in equities. However, you must also recognize that, if you avoid stocks, you will almost certainly have a lot less money and, the longer you live, the difference between what you have and what you could have had will compound…a lot.

All of which raises what is likely the crucial question: Are you a long-term investor? Short-term investors and those whose life situation makes sequence risk a major issue for them should adjust their investments accordingly. Those who recognize that fear might get the better of them in difficult times [Quick Check: How often have you been checking your portfolio in the last month? If your answer is something like, “A lot,” I may well be talking about you here, just sayin’], might consider a portfolio mechanism like a pressure relief valve to try to help manage their fears. A decent portfolio that you can stick with is far better than a perfect portfolio you can’t.


Volatility can cause major deviations in the near-term. On a daily basis (1950-2017), the S&P 500 is positive barely 50 percent (53.7 percent) of the time. Moreover, annual returns for the S&P (1928-2017) have shown a wide variance, from -44 percent to +53 percent within a calendar year. Owning stocks is emotionally difficult. Not everyone is up to it.

However, rolling annualized returns over longer periods are increasingly positive, with lessening variance. For rolling 30-year periods, annualized S&P 500 returns have fallen between 7.97 and 13.63 percent. Even the worst of those outcomes is pretty darn good. Most of us would happily bank eight percent returns for as long as they were offered. Therefore, truly long-term investors shouldn’t worry about market volatility.

To be clear, none of this is cast in stone. Just because something has always worked doesn’t mean it always will. The worst that has ever happened isn’t a limit on what can happen. Things can always get worse. Past performance is not indicative of future results. If you doubt me, ask Japanese investors how “stocks for the long run” has performed for them, or ask risk managers how VaR worked for them during the GFC. It should also be noted that the permabears could (finally) be right today. A market crash may be imminent.

But that’s not the way any of us who are long-term investors should bet. A big market drawdown is much more likely today than it was five years ago, but the probabilities still favor investment, especially for long-term investors. By a lot. Our brains all echo with fearful thoughts, whispers, and imprecations. For most of us, most of the time, we’d do well to ignore them about our investment choices. Instead, we should listen to the Christmas angel, this holiday season and thereafter, and “fear not.”

I wish you all a Merry Christmas, a happy holiday season, and a prosperous New Year.


25 thoughts on “Fear Not

  1. Great post. Fear sells, but I wonder if blind optimism doesn’t sell better. Crypto is a great case study on people who are doing quite well selling the dream, even as those who enrich them become poor themselves.

    I’m not sure that the perma-bears are just selling fear. There is a lot of logic in their arguments. The flaw, of course, is that they are on the other side of the fed and global monetary policy, but now I am getting off topic.

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  13. Personally, I think that people *should* be afraid. No, you can’t time the market, but you *can* determine when valuations are severely out of whack, such as 1999 and today.

    Not only is the stock market richly valued relative to average historical earnings, profit margins have been extremely high compared to historical profit margins. When profit margins revert to the mean, which they will almost certainly do, watch out below.

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