Sooner or later a crash is coming, and it may be terrific
Roger Babson, 5 Sep. 1929
If everybody indexed, the only word you could use is chaos, catastrophe. The markets would fail
Jack Bogle, founder of The Vanguard Group
As of December 2018, passive index funds controlled 17.2% of the stock of all U.S. publicly traded companies, up from only 3.5% in 2000. The 5-fold increase was in part the consequence of the ongoing stock market growth, which now has the distinction of being the longest running bull market ever recorded. Buoyed in large part by central banks’ unprecedented quantitative easing (QE) programs, the rising stocks have lulled many investors into complacency.
However, as John Hussman wrote last year, “In a steeply overvalued market, further advances typically magnify the losses that follow, ultimately wiping out years, and sometimes more than a decade, of what the market has gained.” Japan's 1980s stocks bubble and the aftermath of its bursting offer the perfect example of risks Hussman was talking about.
Japan’s equities bull market lasted throughout the decade of 1980s but then suddenly reversed after 29 December 1989. Over the next 20 years, the Nikkei shed 82% off peak valuations. Today, nearly 30 years later Nikkei is still more than 40% below the 1989 peak. This scenario should be a sobering wake-up call to all the long-only, the-Fed-has-our-back, everything-is-awesome, investors.
How to navigate the coming roller-coaster
Today, it is impossible to say whether US stocks bull market has peaked or whether it might still double from current valuations. Nevertheless, the risks of passive long-only investing should not be ignored or dismissed. The next question is, how should investors navigate the coming market downturn?
One of the methods that’s proven effective in identifying key turning points between boom and bear markets is systematic trend following. Here's an 8 minute presentation summarising the idea:
Alex Krainer [firstname.lastname@example.org] is a hedge fund manager and commodities trader based in Monaco. He’s wrote the book “Mastering Uncertainty in Commodities Trading”