The vast majority of investors will be caught totally by surprise when this bull market in stocks finally comes to an end. Cultivating a healthy sense of skepticism will help protect you from the irrational exuberance that invariably accompanies a market top.
This is far easier said than done, however. Bull markets often end with a burst of impressive performance, leading even die-hard skeptics to question themselves and throw in the towel on their bearishness.
Over the last six months of the bull market that ended in March 2000, for example, the Nasdaq doubled in value. By then, not surprisingly, most of that era’s erstwhile bearishness had given way to enthusiasm and euphoria.
We all know what happened next.
That early-2000 experience was hardly unique. Consider the average recommended stock market exposure among several dozen stock market timers monitored by my Hulbert Financial Digest performance monitoring service. At bull market tops of the last three decades, their exposure level averaged more than 70 percentage points higher than at bear market bottoms.
In other words, the typical market timer was bullish when he should have been bearish, and vice versa.
Bucking the conventional wisdom requires uncommon willpower and determination. But no one said that investing is easy. In the words of Warren Buffett, CEO of Berkshire Hathaway and perhaps the most successful investor alive today, we need to be “fearful when others are greedy and greedy when others are fearful.”
Pay attention to the bears
One way of cultivating a healthy skepticism is to seek out the arguments of advisers who are bearish. Though there aren’t many outright bears these days, you can find them if you try. You’ll discover upon reading their blogs or investment newsletters how the glass that seems half-full to the bulls can also be seen as half-empty.
Some who’ve taken this advice in the past have complained that it leaves them paralyzed. They find that both the bullish and bearish camps contain very smart people. They also realize that there are cogent arguments on both sides, each based on what at least appears to be statistically sound analyses of history. There’s no apparent way of deciding which camp is more worth following.
But being paralyzed is in itself valuable information. If you were otherwise bullish but unable to come up with good counterarguments against the bears, then perhaps you shouldn’t be betting all or nothing on the stock market continuing ever higher. You don’t really want to be bullish if that requires burying your head in the sand.
Invest in "boring" companies
Another way of preparing for an eventual bear market is to begin to shift your stock holdings away from riskier companies towards firms with the strongest balance sheets — as measured by financial quality ratings such as those given by companies such as Standard & Poor’s. The stocks of such firms are likely to go up as long as the bull market continues but lose a lot less than the market when it turns down.
Walmart stock, to provide one spectacular example, actually gained ground during the 2007 to 2009 financial crisis, gaining 7% even while the S&P 500 fell 57%.
To be sure, these higher quality companies, much of whose long-term return comes from dividends, can seem boring at a time when the stock market is regularly hitting all-time highs. But if it’s excitement that you crave, just wait until the next bear market.
One will begin someday.
Mark Hulbert, founder of the Hulbert Financial Digest, has been tracking investment advisers' performances for four decades. For more information, email him at email@example.com or go to www.hulbertratings.com.